Lula wasting no time in Brazil

Summary

Over the last few weeks, President Lula da Silva has moved forward with some of the fiscal policies that he not only campaigned on, but that also worried market participants. Recently, Lula has gathered support to raise constitutional spending limitations and enhance social spending, while he has also promoted the use of subsidized lending from state-owned development banks to drive economic growth. We believe this new direction for fiscal policy will ultimately be inflationary, and we now believe the Brazilian Central Bank (BCB) will delay easing monetary policy until Q3-2023. Moreover, financial markets believe BCB policymakers will resume the tightening cycle before cutting interest rates, which in our opinion presents investors will an opportunity to take advantage of a possible mispricing in Brazilian interest rates. Risks around our Brazilian real forecasts are also rising, and while we believe the currency can hover around current levels in the short-term and strengthen over the longer-term, more explicit evidence of an erosion of fiscal responsibility would prompt us to change our outlook on the Brazilian currency.

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