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BRAZIL’S central bank, Banco Central do Brasil, was one of the first global monetary authorities to start lifting interest rates.
It was tough medicine but now the top-ten economy is reaping rewards earlier than its peers,” argues James Syme, co-manager of Pendal Global Emerging Markets Opportunities fund.
Syme and his London-based team EM take a top-down, country-level approach to the asset class.
“Brazil’s central bank has run orthodox monetary policy for three or four years, more so than most other central banks,” Syme says.
“When they started hiking rates in the first quarter of 2021, Covid was still a huge problem in Brazil. But inflation expectations pushed above target, and they ultimately pushed rates to 13.75 per cent.”
The early shift is now paying dividends.
“Brazil took the medicine and on the back of that it got anchored inflationary expectations and a strong currency,” Symes says.
“First-quarter 2023 GDP came in at 4 per cent, and consensus was 3.1 per cent. The May inflation number was expected to come in above 4 per cent but came in below 4 per cent.
“There has been very significant disinflation in the economy and inflation is now around the central bank’s target range.”
Banco Central do Brasil will cut rates at some point in the next year, Syme says, though they will do it cautiously.
He expects rate cuts, ultimately, will exceed 300 basis points.
“When these rate cuts come through, they will happen in an economy that’s already, on the domestic front, growing quite strongly,” he explains.
“Across the domestic economy there are strong positive numbers and beats relative to consensus, despite there being no rate cuts yet. And that’s a really exciting environment.”
A reason why Brazil will keep growing, according to Syme, is the stable currency, the Brazilian real.
It was sold off during Covid, losing nearly 50 per cent of its value against the US dollar. More recently it has appreciated against the greenback.
“That strength in currency reduces the cost of imported goods, which are a meaningful part of the inflation basket,” Syme says.
“So in economies like Brazil, a strong currency reduces inflation which enables more rate cuts..
“In emerging markets, typically everything goes wrong, or everything goes right.
“If things go right, you typically get capital inflows, a stronger currency, a better inflation outlook, the prospect for yields to fall, equities going up along with economic growth, and that eases any political stresses.
“And we think that is where Brazil is now.”
Brazil is the stand-out example of a number of emerging economies that pre-Covid struggled economically but are now providing investors’ with opportunity, Syme argues.
“We are seeing broadly similar patterns in India, Indonesia and Mexico.
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“Long, deep downswings tend to be followed by long upswings and that’s broadly what we expect will happen with these economies.
“Brazil really has been the surprise. We thought rate cuts would be needed to really get the economy going.
“But it seems that through what higher commodities and prices are doing to the economy and through the natural tendency for the domestic economy to recover, Brazil is doing well already with the potential for more good news when the cuts come through.”
James Syme, Paul Wimborne and Ada Chan are co-managers of Pendal’s Global Emerging Markets Opportunities Fund.
The fund aims to add value through a combination of country allocation and individual stock selection.
The country allocation process is based on analysis of a country’s economic growth, monetary policy, market liquidity, currency, governance/politics and equity market valuation.
The stock selection process focuses on buying quality growth stocks at attractive valuations.
Find out more about Pendal Global Emerging Markets Opportunities Fund here
Pendal is a global investment management business focused on delivering superior investment returns for our clients through active management.
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