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Latin American central banks are still more aggressive than the Fed

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(Bloomberg) — Look at inflation rates, and the largest economies in North and South America seem to be on the same page. Look at interest rates, and you might as well be on different planets.

Brazil’s central bank is forecast to raise its benchmark rate by 100 basis points to 11.75% on Wednesday, bringing the total amount of hikes over the past year to 975 basis points. On the same day, the US Federal Reserve, which has kept rates close to 0% since the covid-19 pandemic began, is expected to announce a quarter-point hike.

The figures show how different the approaches to inflation have been during the pandemic in Latin America and the US. What is also striking is that investors reacted in the opposite way when the news of the latest global shock to prices emerged: the Russia’s invasion of Ukraine, which uses a sharp rise in oil.

In São Paulo, traders’ reasoning was simple: They thought more expensive oil translates into higher inflation, so they increased bets on sharper rate hikes. Economists now expect the central bank to go further with its tightening cycle than it did a month ago, before the Russian attack.

What Bloomberg Economics Says

“The central bank of Brazil has important obstacles to overcome. Rising oil prices prompted Petrobras to announce double-digit price hikes for gasoline, diesel and cooking gas. So prompted the government to announce measures to reduce those pressures, but at great fiscal cost. This is on top of high and widespread inflation and rising unanchored inflation expectations.”

— Adriana Dupita, Latin American economist

— Click here to see the full report

Inflation expectations are also related to what has been guaranteed in the US since the war began, but there, the initial market response was quite different. Traders took the argument one step further, thinking higher inflation will undermine consumer demand and slow economic growth. So they initially reduced bets on Fed hikes.

oil fluctuations

Since then, the outlook has become uncertain. Fed hike expectations are back roughly to where they were a month ago. And oil has tumbled from post-invasion highs, in part due to the new Covid shutdown in China, which poses risks of its own to global supply chains as well as demand.

In the US, bonds slumped on Monday due to a combination of rising inflationary pressures and a looming monetary tightening. In Brazil, expectations for year-end inflation rose 80 basis points – and for interest rates, 50 basis points – in the central bank’s latest weekly survey.

There are many reasons why central bankers in Brazil – and also elsewhere in Latin America, where tightening has been under way since mid-2021 – respond to a price shock differently than their American peers.

In Brazil, a volatile emerging market, policymakers are terrified by recent memories of hyperinflation. They also have to worry about risks like capital flight and currency collapse. They tend to act on the first season of a price increase, even if it means an economic slowdown. Last year, the country fell into its second recession of the pandemic period.

In the US, a stable developed economy, the concern over the last decade has been the opposition: that inflation may be falling too low.

Reason to be afraid?

However, the rising rate brusque across countries comes at a time when their inflation woes are quite comparable – Brazil’s annual rate soared from 4% at the start of the pandemic to 10.5%; in the US, it rose from 2.3% to 7.9% – and has been driven by very similar causes.

It is possible that each country has chosen the right path in its own context, and also that each has something to learn from the other.

Henrique Meirelles, Brazil’s longest-serving central banker, reckons the Fed will end up moving at least a little in the direction of its Brazilian counterpart.

“USA. it certainly needs a strategy plus aggression,” said Meirelles, who raised rates to a shocking 26.5% shortly after taking office in 2003. It allowed him to control inflation expectations, and only a few years later he would cut rates to a minimum. record this time.

“There is no reason for the Fed to be afraid of raising rates,” he said. “They are facing a classic inflation spike: excess demand, fiscal stimulus and low unemployment.”

But in a global economy now buffeted by one shock after another, José de Gregorio, who presided over Chile’s central bank during the 2008 financial crisis, can see some merit in the “act and see what happens” strategy.

According to De Gregorio, Latin America cannot stop the adjustment, but the appropriate response with these levels of global uncertainty would be to wait, he points out.

original note:

Oil shock widens gap between Latin American rate hawks and Fed

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