Thanks to higher demand for risky assets, and India’s better-than-expected GDP report yesterday, many investors are once again bullish on emerging markets. These nations often have better growth prospects and balance sheets than their developed market counterparts making them ideal choices for investors seeking higher rates of return. Yet, many of these markets are also struggling against high rates of inflation, a situation that is putting pressure on emerging nations around the globe. One nation that has been at the forefront of this battle is Brazil, where the benchmark interest rate is a major-economy leading 12.5%. Whether this significant rate is too high or not high enough, however, will likely be discussed later today when the country’s central bank meets to give its decision on rates.
The Bank of Brazil has already raised rates several times this year, from 10.75% to start 2011 up to the current level of 12.5%, a 175 basis point jump in a matter of months. Despite these increases, inflation is still rising, albeit modestly, up to an uncomfortably high rate of 6.28% for the year. However, it should be noted that inflation is expected to fall modestly next year, down to roughly 5.2%, but this may just be attributed to the nation’s slowing growth rate more than anything. In fact, Brazilian growth is expected to be just 3.84% for the year, a huge decrease from last year’s rate which was the fastest pace in 24 years.
Thanks to slowing growth and moderating medium term inflation fears, some are calling for the central bank to ease rates from their extremely high level at today’s meeting. Furthermore, some analysts are pointing towards Monday’s announcement of caps on spending as more reason for a cut. After all, if the government is going to cut spending, this is somewhat deflationary and could help to moderate inflation even more, making a modest rate cut within reason for South America’s largest economy. Nonetheless, all economists polled by Reuters in a recent survey expect the benchmark Selic rate to remain unchanged at 12.5%, suggesting that many Brazilians may have to wait for the next meeting for a cut. “The central bank may want to lower interest rates, but there still aren’t numbers to justify this,” said David Rocha, a fixed-income trader at Renasenca DTVM Ltda [see Emerging Market ETFs: Seven Factors Every Investor Must Consider].
Thanks to this key central bank meeting, investors should look for the iShares MSCI Brazil Index Fund (EWZ) to be in focus in today’s trading session. The fund tracks the MSCI Brazil Index which measures the performance of the Brazilian equity market by investing in nearly 90 companies based in the South American country. Top weightings go to giants such as Petrobras and Vale, although a large number of banking companies are represented as well in this extremely popular fund [see all the Latin America ETFs here].
So far in 2011, it has been a pretty rough year for investors in EWZ as the fund has declined by 18.3% since the start of January including a nearly 10% loss in the past month alone. With that being said, EWZ has gained close to 5.2% over the past week and could continue to surge if fears over the global economy subside. If the central bank cuts rates, it could signal to investors that inflation is under control and could push funds such as EWZ higher on the day, extending their recent gains. If, however, investors see a hike in rates, that would definitely be a sign that more inflation is coming down the pike and could lead EWZ to continue its trend downward heading into the final quarter of the year. Lastly, if the bank holds rates steady, the key will be in the central bank’s forecast as many will look for a hint at a cut sooner rather than later in order to soothe worries over the longer-term health in the Brazilian economy [also read FBZ: A Better Brazil ETF?].
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Disclosure: Long EWZ, photo is courtesy of Marcelo Matarazzo.