As global economies grapple with the challenge of unwinding massive stimulus plans in an orderly manner, central bank meetings have taken on a new importance. Following a relatively uneventful meeting of the Federal Reserve, Brazil’s central bank took center stage this week, deciding to keep rates steady at a record low of 8.75%. Some investors were surprised by the move since inflation, recently recorded at 4.83%, has surged above the Bank’s target of 4.5%. The news had an interesting effect on Brazilian markets; the iShares MSCI Brazil Index Fund (EWZ) lost close to 1.5% and the WisdomTree Dreyfus Brazilian Real Fund (BZF) dropped more than 0.9%.
“Evaluating the macroeconomic scenario and the outlook for inflation, the [Central Bank Committee] decided to hold the Selic rate at 8.75 percent a year, without bias, with five votes in favor and three votes to raise the Selic rate by 0.5 percentage point,” read a statement released yesterday. “The committee will carefully monitor the development of the macroeconomic outlook until its next meeting, to then define the next steps of its monetary policy strategy.” This suggests that there was significant disagreement among the Central Bank members, and perhaps is an indication that rates will rise in April. “The split vote is the final signal that the central bank normally gives before changing monetary policy,” said Silvio Campos Neto, chief economist at Banco Schahin in Sao Paulo.
The setback continues the rough year for EWZ which has lost 2.8% since calendars turned to 2010. In addition to overall weakness in the Brazilian economy, a stronger dollar has significantly hurt commodity producing equities, which make up a substantial portion of EWZ. In fact more than one-half of the total assets of EWZ are in the materials and energy sectors, suggesting that further weakness in commodity prices could keep the Brazilian ETF down in the near-term.
On the currency front, BZF is now down about 1% for the year after the central bank’s most recent decision did little to attract foreign investors. Central banks in many other emerging markets (and even developed economies) have begun to raise rates, putting extra pressure on Brazil to match the increases with hikes of its own. In addition, some are growing concerned that political pressure may be building on the bank to keep rates low ahead of the elections later this year. If this appears to be the case, it could lead to further weakness in the currency, which despite its recent weakness, is up more than 33% over the past 52 weeks.
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Disclosure: Eric is long EWZ