1、17/07/19|FLASHGustavo Arruda,Senior Economist|BNP Paribas do Brasil SA Luca Maia,LATAM FX/IR Strategist|BNP Paribas do Brasil SABrazil Conservative easing cycleKEY MESSAGES We now expect Brazils central bank to start its easing cycle in July,instead of September.The BCB is likely to cut about 100bp
2、in total,we think,in 25bp increments.On balance of risks,we believe the BCB would prefer to stay on the conservative side by cutting less and at a smaller pace,rather than run the risk of having to hike rates too soon.The size of the cycle and the pace of cuts might change if the economy does not re
3、act to the stimulus.The central bank has the green light from the Congress to start the easing cycle from July.In its latest communication,the central bank had indicated that any eventual stimulus would come only in the event of a concrete step forward in fiscal consolidation.Following the recent po
4、sitive step in the pension reform,which are expected to save about BRL850bn in 10 years,BCB should be more comfortable to act now.Both inflation and growth indicate the need for policy action.We now believe that the upcoming monetary policy easing cycle is not a matter of if or when but of how much
5、and how fast.We expect the central bank to be cautious.Between the two known risks of starting an easing cycle,we expect the BCB to be more conservative and run the risk of cutting less than needed,and being obliged to cut for longer and at the end see inflation failing to converge to the target,rat
6、her than run the risk of having to hike rates sooner because of extra aggressiveness.Reasons to be cautious Pending social security reform:Although recentdevelopments were positive,this landmark overhaul stillneeds to pass a second vote in the Lower House inAugust and then to win approval by the Con
7、stitution andJustice Commission in the Senate before beingapproved by 49 of 81 senators in two rounds of votes.All going well,we expect the process to end in lateSeptember or October.Fiscal stimulus:The government is reportedlyconsidering a repeat of the programme that allowedhouseholds to access co
8、mpulsory savings that are nowblocked by law(FGTS).When former president Temerimplemented the measure,it had a sizeable impact on consumption.Although the expectation is for a smaller programme,the size,agenda,or the number of households that are likely to benefit have not yet been determined.In othe
9、r words,the potential boost to demand is of uncertain size and impact.Possible global bounce back:Brazils disappointinggrowth was accompanied by a deceleration in othereconomies.Central banks in advanced and emergingeconomies are now in an easing mode.This quasi-synchronised monetary policy may star
10、t to accelerate orat least stabilise global economic growth.Althoughmonetary policy easing in Brazil is cyclically justified,itshould be viewed in the context of the global economyand monetary policy stance.All told,we believe the BCB will start a conservative easing cycle.Although markets are curre
11、ntly pricing in a high probability of a 50bp cut at the July meeting,we believe the BCB will opt for a more steady process,cutting rates by a marginal 25bp per meeting from the start of the cycle,probably finishing at 5.5%from current 6.5%.The central bank will likely keep the doors open to adjust t
12、he pace of cuts if required by growth and inflation,which should work as a barometer that helps the BCB to gauge the size and timing of the required stimulus.We think a 25bp cut in July seems like a good starting point.After earlier taking profits on the FRA Jan-22s23s receiver and recently on the J
13、ul-20sJan-22s flattener,our strategy team believes that the DI curve remains too steep.This is why they decided to re-enter into Jan-21sJan-25s flatteners.The aim was to get the most out of(a)the term premium model,which still points to premium for 5y tenors;(b)the positive impact of the pension ref
14、orm via structural lower nominal rates in the long end of the curve;and(c)the systemic global compression of rates,to which local IRS are not immune.Additionally,they decided to pay rates in DI April-20 as they see the short end of the curve pricing in a more aggressive monetary policy than what the
15、ir models suggest(see Brazil Take profits on short-end receivers;going into payers).EM ECONOMICS FLASH|LATIN AMERICA17 July 2019 Please refer to important information at the end of this report.MARKET VIEW1 LEGAL NOTICE This document has been written by our Strategist and Economist teams within the B
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