Six weeks ago, I compared with striking similarities between Brazil’s monetary cycle to that of the US a year later, and warned that the US should be careful not to fall into Brazil’s trap of cutting to quickly while broad conditions remained robust, and finding themselves having to hike again within the year. At the time, US 10y rates were below 4%, and they have marched steadily higher since. Let’s revisit some of the themes and charts to see ->
Spot Inflation: While progress on inflation has been solid, it remains above target (and core more so), and next week’s PCE print is expected to pop headline into the mid-2s. Brazil’s numbers are similarly sticky above 4%: that elusive ‘last mile’ looks challenging without a hit to growth, begging the question whether a soft landing is a landing at all. I’m skipping the inflation graph, but do look at the ‘scary’ monetary policy chart. To really spook you, Brazil is currently pricing a terminal rate ABOVE 14%; the equivalent of the US re-hiking above 5.50%.
F2 (updated): Selic and Fed Funds (1y lagged)…. The risk is clear:
Inflation Expectations: As discussed below, expectations drive the ‘real’ CB reaction function. My chart in the previous piece was accused of being somewhat intelligible, so I’m splitting out Brazil and the US to make the point. Note (as before) how the linker pricing trajectory leads monetary policy.
F3 (updated and split out)… Brazil first, showing how that recovery in inflation expectations curtailed the cycle and pushed the CB back to hikes…and the US, where the 50bp recovery in the last 6 weeks could be a concern.
Could the Fed fall into the BCB’s trap? The panicky 50bp opener was not impressive, and the risk to increased politicisation of the Fed certainly feels greater than it did 2 weeks ago. Nevertheless, they already seem live to the risk of over-cutting, and US terminals have repriced ~75bps higher in the past 6 weeks. Still, if they cut below 4% (as currently priced) and the labour market remains in ‘soft-landing’ setting, the risk is there.
What about the other factors? My previous remarks that ‘Brazil is not the US’, especially in the fiscal sphere, may require re-examination. The memeification of the executive branch is undeniable (DOGE anyone?) and its ability to deliver tangible results on cost cutting remains to be seen, but the market has its doubts. Meanwhile, sizable tax cuts, forcible removal of a chunk of the labour force, tariffs on trade all point to continued upward pressure on inflation expectations.
Closing thoughts: US activity remains robust and labour tight, like Brazil before it. Neutral rates certainly look higher than previously thought, but the risk of further fiscal deterioration has become something the market will no longer ignore. The tails contain a failed UST auction on the right (payer side), and a sizable cracking in the jobs market on the left. Payers remain the more attractive base case for now.
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