Brazil Update: Meirelles Stays, BRL Firm

Brazil's central bank President Henrique Meirelles has decided to resist the temptation of politics and will stay at his post. Speculation that Meirelles would step down may have been a slight negative for the Brazilian real, which has lost almost 0.9% against the US dollar this year.

The outlook for monetary policy is largely the same, even though the IPC (weekly urban) and the FIPE inflation measures have moderated a bit. The central bank meets on April 28th. Some observers had expected a rate hike in March and although the central bank did not move, an April hike is as certain as these kinds of things get. What is at issue is whether the move is a 50 bp hike or 75 bp.

Last week, the central bank updated its inflation forecasts. After a 4.3% rate last year, the central bank forecasts inflation will rise to 5.2% this year before slipping back to 4.9% next year. The upper end of the target range is 4.5% .

With the central bank moving into a tightening mode, it may be more willing to accept some currency appreciation, which it had been resisting previously. Key support for the the dollar is seen near BRL1.70, though it has not been below BRL1.75 since mid-Jan. We also note that the main source of price pressure appears to be coming from food prices and it is not clear if a strong currency or higher interest rates helps very much.

Meanwhile, Japan's appetite for Brazilian bonds is expected to remain strong at start of the new fiscal year in Japan and these inflows should help underpin the BRL.

Lastly, we note that the Brazilian real is among the most correlated currencies with oil prices. The price of oil has rallied to 17-month highs today. The impetus seems to be the broadening of the global economic recovery. The rally in oil prices has taken place despite US inventories rising for nine consecutive weeks and at 354 mln barrels for the week ending March 26th, the Dept of Energy says it is 6.5% above the 5-year average.

Thus far this year, BRL is 68% correlated with crude oil prices (daily correlations run on percentage change). Last year the correlation was 53% and in 2008 the correlation was just shy of 32%. For the record, the Norwegian krone appears to be the second more correlated at near 67.5%. The South African rand, Canadian dollar and Australian dollar are near 62% correlated. The euro is a little more than 54% and sterling a little less than 49% correlated with oil price movements.

To be sure correlation is not the same as cause-and-effect. And the correlation with oil prices might really be a correlation with commodity prices in general, which in turn may be correlated with world growth.

In any event, the combination of the prospects for a 50-75 bp rate hike in a few weeks and rising commodity prices, especially oil, and continued inflows from yield hungry Japanese investors should be expected to help underpin the Brazilian real.