Forex Investment and Currency Trading

Brazil: The monetary policy committee (COPOM) hiked the overnight Selic target rate by 50bp to 11.75%. The move was a surprise to most analysts, where 25bp represented expectations. In a brief statement, COPOM clearly demonstrated a desire to be highly preemptive in its approach to restraining inflationary pressures. The decision was designed to “immediately carry out a relevant part of the adjustment of the interest rate” which would “contribute to an opportune lowering of the risk that designs the inflationary scene” and “ultimately reduce the magnitude of the total adjustment necessary.”

The decision to hike the Selic rate comes at a time when the targeted IPCA inflation index has exceeded the 4.5% target for the last three months and inflation expectations are slowly creeping higher. IPCA increased 4.73% yoy in March. The Central Bank (BCB) currently expects inflation to peak at 4.90% by the end of 3Q 2008 and settle at 4.40% by end 2009. However, given the risks of an upside surprise to these inflation projections COPOM is likely to maintain a hawkish tone going forward and remain committed to further rate hikes if necessary.

For markets, the move is meaningful especially as this represents the first hike since May 2005 as well as signals COPOM’s desire to whip modest inflationary pressures. The move could also reinforce a recent trip by Finance Minister Mantega—lobbying for an Investment Grade rating. USD/BRL will likely test and break the recent low of 1.6590 as well as support of 1.64. Upcoming monetary minutes released on April 24 will likely reinforce the notion of preemptive action by BCB.

Mexico: As anticipated, Banxico kept monetary policy unchanged leaving the overnight lending rate at 7.50% at its March monetary policy decision announcement. However, the statement was clear that the authorities expect inflation to increase, due to external and internal pressures. On the external front, the pressures are clear—food and energy. Internally, the CB is concerned regarding the potential impact of the tax reform-pushing prices higher. The authorities will likely raise the inflation forecast band from 4%-4.5% to perhaps as high as 4%-4.75% relative to 4.25% at present. The authorities will watch inflation within the context of the potential for a slowdown in economic activity—which has actually yet to present. That said—the statement and Banxico’s prioritization of an inflation target make the commentary somewhat hawkish and should be supportive of a near-term test of 10.39 for USD/MXN.

We will likely see inflation expectations incorporating these upside risks to inflation from rising energy and food prices and therefore pushing-back expectations of some large market participants of an imminent monetary policy easing from Banxico until the inflationary outlook improves.