Dovish Brazil, but Firm Real

The market is talking about the dovish cast to the minutes of the recent central bank meeting. It seems to be among the strongest signals to date that policy is on hold. The market had already pushed out expectations for a hike into next year and now are scaling even those back a bit.

The dovishness of the minutes has ben further driven home by the slippage in the IPCA inflation measure for August reported today. It slipped to 4.49%, the lowest in 8-months and down from 4.6% in July and a peak near 5.25% in April. It is the first time this year that inflation fell below the 4.5% mid-target.

This is where many analysis stops. However, it is important that inflation expectations are still firm at 5% over the next 12-months. Going forward, inflation expectations need to ease for investors to feel confident that rate cycle is truly over, rather than just a pregnant pause.

The Brazilian real remains bid and near BRL1.72, the dollar is just above the year low set in Jan near BRL1.7155. The market's response to the dovish minutes is in line with the market's reaction to South Africa's as expected 50 bp cut, where the rand remained bid and with the reaction to South Korea's unexpected decision to keep rates steady and the won rallied (after an initial wobble). The risk-on/risk-off matrix may help explain the price action. In addition, even at current levels, Brazil's rates are among the highest in the world and are sufficient to attract funds.