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Risks in a low inflation Brazil

It is no understatement to say that the country is uncharted territory. The news is all good right now. But next year’s presidential election could return it to familiar, volatile territory.

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Do you remember the joke about central banking and trading that did the rounds when global quantitative easing was in full swing? 

There were variations around the theme that good economic news was positive for shares and so traders bought. And when data was bad, that led to expectations of further monetary expansion, which was positive for shares and so traders bought.

A similar thing is happening in Brazil with the central bank and expectations for rate cuts. The market sees any increase in the chance that the government will pass pensions reform as a positive for the country’s weighty fiscal problem and, as monetary policy won’t be alone in fighting inflation, that opens up scope for further rate cuts. 

Meanwhile, spikes in political risk lead to lower chances for big fiscal reform, which in turn will dampen the nascent recovery – and that economic weakness opens space for the central bank to make further rate cuts (in the short term, clearly the longer-term narrative for inflation and therefore rates is different).

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