He-said, she-said

Maybe it was relief after Friday's vicious expiry-led sell-offs on both side of the Atlantic.   Maybe it was the recent game of He-said, She-said from Williams, Bullard, and Lockhart that brought balance to the (monetary) force.   Either way, yesterday was a damn sight calmer than it's been as markets appeared to realize that the Fed might not be on hold forever, after all.

Equities, the dollar, and short-end yields all managed to post modest rallies yesterday.  While Macro Man has reloaded his January Fed funds short, he retains some more room to add should things get silly again.  Despite their adherence to the view that a 2015 lift-off is still very much in play, both Williams and Lockhart more or less admitted the obvious- namely, that there really isn't enough to time before the October meeting to get the additional data that the Fed apparently craves to dot the i's and cross the t's in triplicate before raising interest rates for the first time.   December it is then! (Unless it isn't.)

One area of fallout from the dollar's modest recovery has been in Brazil, where the dollar's strength has been anything but modest.  USD/BRL is knocking on the door of 4.00 and is at record highs.  If it weren't obvious, the weakness of the currency is creating a negative feedback loop for the economy and policy.   Until that loop is broken, Macro Man will find it very, very difficult to become bullish on Brazilian equities, no matter how cheap they appear to have become.

At 9.5%, inflation is at its highest level since 2003; given that the BRL has depreciated a further 10% in the month since the last inflation figure, it's difficult to see the inflation trend going anywhere but up, especially once more time passes and a wage/price spiral sets in.

To be sure, Bacen has responded with rate hikes this year, and at 14.25%, the SELIC rate is the highest it's been since 2006.  To put that into context, however, when the SELIC was last at these levels, CPI inflation was just 3.7%...and falling.

The current real SELIC rate of 4.72% is extraordinarily high by global standards- indeed, very few countries can boast of a nominal policy rate that high, let alone a real one.   However, by Brazil's own standards it remains fairly low- since 2003, the average real SELIC rate has been 6.55%.   Moreover, during prior periods of abject currency weakness, markets eventually demanded double-digit real rates as a sufficient risk premium to put money into the BRL.

Needless to say, double digit real rates do not exactly engender high multiples for the equity market.   Even with the recent sell-off in the Bovespa, the expected earnings yield of Brazilian equities is some 6% below the short-term cash rate, which doesn't exactly scream "buy me", does it?

Frighteningly, during Brazil's last experience with sharp currency weakness, the real SELIC rate lagged the exchange rate by some two and a half years.  If history were to repeat itself, equities
would face the overhang of expected higher real rates until well into 2018.

That's not to say that the Bovespa will tank in a straight line for the next two and a half years, of course.  What it does suggest, however, is that there are likely to be easier fish to land than the one that lets you buy Brazil just before it embarks on a secular bull market.