Over and over, Jerome Powell, chairman of the Federal Reserve, hammered the point home: Inflation wasn’t high enough. It needed to keep rising, he told reporters, and then stay elevated to help convince him and his colleagues that the economy was recovering from the pandemic shock. Until then, there would be no interest-rate hikes.
(Bloomberg) — Over and over, Jerome Powell, chairman of the Federal Reserve, hammered the point home: Inflation wasn’t high enough. It needed to keep rising, he told reporters, and then stay elevated to help convince him and his colleagues that the economy was recovering from the pandemic shock. Until then, there would be no interest-rate hikes.
This was early on the afternoon of March 17, 2021.
Three hours later and 4,000 miles away, Roberto Campos Neto, the president of Brazil’s central bank, delivered a very different message. Facing the same broad macroeconomic forces in Brasilia that Powell confronted in Washington — unprecedented fiscal and monetary stimulus coupled with supply-chain constraints — Campos Neto orchestrated the biggest rate hike in a decade to contain the inflation spiral he saw brewing.
Over the next year, as policymakers at the Fed and ECB kept rates pegged at zero, Brazil would lead a rate-hiking blitz across the region — in Chile, Colombia, Mexico, Peru and Uruguay. In Brazil alone, Campos Neto would lift them eight times — and by almost 9 percentage points — before Powell made his first move.
Now, Brazil — and Latin America, more broadly — is leading the world on the way down, too. With inflation both below the government’s 3.25% target and, in a rare twist, nearly identical to that of the US, Campos Neto is poised to start cutting rates tomorrow, one week after Powell raised them for an 11th time and signaled more could come. In Chile, the cuts are already underway — a full percentage-point reduction on July 28.
“History saved us,” says Sandro Sobral. A managing director of markets and treasury at Banco Santander SA in Sao Paulo, he worked closely for 10 years with Campos Neto, who, he came to realize, had the same aversion to rising prices that countless other Brazilians developed after suffering through 3,000% inflation in the 1990s. “That’s why central bankers lifted fast and lifted the most.”
Inflation, to be fair, did spike earlier in Brazil than it did in the US and Europe, which helped Campos Neto comprehend the urgency of the matter before his peers did there. Moreover, letting one’s own life experiences — hyperinflation in this case — influence policy decisions doesn’t always work out. It’s just that it did this time around.
Even there, though, some critics of the rate hikes argue they’ve actually played a small role in containing inflation in most countries. In Brazil’s case, they achieved, if nothing else, one crucial thing: a torrid currency rally. The real is up 18% against the dollar since that first hike back in 2021, reversing a plunge that was driving up import prices and accelerating the surge in inflation.
Record Low
While Brazil tamed hyperinflation in the mid-90s, there’s been plenty of turbulence since. Rates were abruptly hiked to 45% in 1999 to stabilize the currency and, more recently, had to be jacked up once more as prices ran at almost double the central bank’s target in the mid-2010s.
So by December 2020, when dynamics deteriorated just months after policymakers brought rates to a record low to bolster the economy amid lockdowns, they began warning they may be unable to fulfill their pledge to keep them there for long. Three months later, they pulled the trigger on the first hike.
The picture was similar in other emerging-market economies, made worse by the passiveness showcased by policymakers in the US and Europe, which helped add to inflation across the globe.
In Peru, there’d be 18 consecutive rate hikes. In Chile, eleven. Inflation is now slowly easing back to target in most of the region, allowing some smaller countries like Uruguay and Costa Rica to already begin easing cycles. Colombian officials have signaled they’ll do the same in September, while in Mexico expectations point to lower borrowing costs in the last quarter of 2023.
“Latin America had an eye into the future,” said David Beker, an economist with Bank of America in Sao Paulo. “We know more fiscal stimulus leads to higher inflation.”
Rate cuts can’t come soon enough for the region’s largest economy. Beker himself, along with many traders, expected Campos Neto, 54, to begin lowering the benchmark rate, known as Selic, months earlier. The pace of inflation was slowing and Luiz Inacio Lula da Silva, who took office in January pledging to restore prosperity, was growing impatient with Campos Neto as the economy sputtered.
The bank cited “patience and serenity” in a statement in early May explaining its decision to wait.
Read More: Lula Lashes Out and Sends Warning to Central Bankers Everywhere
This hard-line stance, along with help from energy tax cuts and the passing of key reforms, has pushed down inflation expectations, paving the way in turn for an uptick in economic growth forecasts. And in the past few weeks, both Fitch Ratings and S&P Global Ratings have improved their views on Brazil, adding fuel to the currency rally.
Critics
There have been plenty of Campos Neto critics. Not just in political circles but also in C-suites and labor unions, where they bemoan how the 13.75% Selic rate makes it prohibitively expensive to borrow and invest.
Analysts, including Beker and Sobral, also fault him for taking the rate as low as he did — just 2% — early on in the pandemic. That, they say, deepened the rout in the currency that forced him to reverse course so quickly in 2021. The bank itself eventually acknowledged that it brought rates down too far.
Much of the success of Brazil’s rate-cutting campaign now depends on what the world’s major economies do next. Traders in Sao Paulo are assigning a 53% chance of a half-point cut on Wednesday and almost a 63% chance of another half-point move a month later, far faster than the gradual pace the central bank has indicated it will proceed at.
Campos Neto has said an “organized” pause in the global tightening cycle that doesn’t disrupt credit channels should help Brazil’s disinflation. But a disconnect with global moves could take a toll on the currency and, in turn, spark a rebound in inflation.
What Bloomberg’s Strategists Say….
The Chilean central bank’s aggressive initial move in its easing cycle will further add to political pressure on policy makers, and is pushing Brazilian traders further toward a 50-bps cut this week.
— Davison Santana, FX strategist
In the past week, both the Fed and the ECB left the door open for more interest-rate increases at their next meetings in September. The Bank of Japan, meanwhile, surprised investors by edging closer to ending its extraordinarily loose monetary policy, potentially adding pressure on currencies sought after by carry traders like the real and the Mexican peso.
Read More: Dawn of Interest-Rate Pivots Threatens EM’s Standout Trade
Reining in price pressures is a “lengthy” and “economically costly” process, former Brazil central bank director Carlos Viana and Fernanda Nechio, a researcher at the San Francisco Fed, wrote in a recent research paper.
Rising inflation estimates in the US and last year’s sudden bond selloff in the UK show that “policy credibility can be challenged even in advanced economies,” they added.
“The fact that Brazil acted very fast, based on all its experience fighting inflation, allowed it to put a stop to rising expectations in time, unlike other countries,” said Henrique Meirelles, Brazil’s longest-serving central bank chief. “They hiked rates at the right time. They will cut at the right time.”
–With assistance from Davison Santana and Enda Curran.
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