LCA Weekly Macro View: Renewed hopes of a pension reform can lead to a somewhat more benign scenario in Brazil in 2018

LCA Weekly Macro View: Renewed hopes of a pension reform can lead to a somewhat more benign scenario in Brazil in 2018

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Chamber Member News Post Date: 11/27/17 Source: LCA Consultores By: LCA Consultores
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Summary

Recent developments in the US economy - such as positive activity indicators (especially industrial production) and the House approval of the tax reform - have reinforced the prospect of further rate hikes by the FED in the short term.

Indeed, the probability of two rate hikes by March 2018 - that is, two increases in the next three FOMC meetings - jumped from about 5% in early September to above 50% this week, pushing interest rates on short-term US Treasury Bonds around 50 basis-points higher.

Although short-term interest rates have remained on an upward trend, the rise in the US Dollar Index has been somewhat reversed. This, because the interest rates on long-term Treasury Bonds have not risen in the same proportion as the interest rates on short-term bonds, as the market implied curve for the FED Funds Rate still anticipates only one to two hikes in 2018 - as opposed to three hikes signaled by the median forecast of the FOMC members.

If, as we expect, the bond markets are underestimating the pace of policy normalization by the FED in 2018, then the emerging currencies (including the Brazilian Real), should face some further moderate depreciation next year.

On the other hand, renewed hopes of a pension reform - after Temer has promised changes to his cabinet - have led to the Brazilian Real outperforming other emerging currencies last week and at the beginning of this week.

If the pension reform should be approved by the Brazilian Congress by year-end - even in a reduced version of the original text -, the Brazilian Real can continue to outperform other emerging currencies in 2018, as political and fiscal uncertainties should wane, especially if the economy consolidates a recovering path.

We are still reluctant to change our call for the Brazilian Real in 2018, which foresees a moderate depreciation, once the approval of the pension reform is still expected to face many hurdles and there remains a lot of uncertainties regarding the 2018 elections. But the chances of a more benign scenario seem to have increased somewhat.


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