US bank collapse could facilitate interest rate drop in Brazil

The collapse of Silicon Valley Bank (SVB), the 16th largest bank in assets in the United States and specializing in serving startups, and other smaller banks – the regional NY Signature and Silvergate, specializing in cryptoassets – could make cause the Fed (the US central bank) to reduce the pace of interest rate hikes in the largest global economy.

If confirmed, this containment of monetary tightening in the US would have positive effects here in Brazil. With a slowdown in interest rate hikes in the US, there is a growing chance that the Brazilian Central Bank will anticipate the beginning of the fall in the Selic, our basic interest rate. Today it is at 13.75% a year, the highest level in six years.

But, depending on its extent, the bank failure scenario in the world’s largest economy could also have negative effects.

A movement of risk aversion would lead more investors to invest in dollars, which would make the US currency more expensive. And the uncertainties can lead to a reduction in investments and consumption worldwide, also harming economic activity in Brazil (read more below).

The chance of falling interest rates in Brazil grows

The perception that the BC may start lowering the Selic rate sooner than expected led to a significant drop in future interest rates in the Brazilian market on Monday (13).

“The Fed, reducing the rate of increase over there, makes room for the Copom to start the downward cycle over here”, says analyst João Vitor Freitas, from Toro Investimentos.

According to the latest edition of the Focus bulletin, on Monday, the midpoint of economists’ expectations for the Selic at the end of this year was 12.75%, with the possibility of cuts in the last two meetings of the Monetary Policy Committee (Copom) , scheduled for November and December.

With the prospect of a smaller monetary tightening in the US, some Brazilian banks and consultancies are starting to review their scenarios. More pessimistic than the market median, Banco Fibra expected until a few days ago that the Selic would remain at 13.75% for the whole year. But now he expects the Copom to start reducing the rate in June, making five consecutive cuts of 0.25 percentage points, which would take the rate to 12.5% ​​by December.

The room for cuts could be even greater, depending on how the new fiscal framework is formatted. According to Freitas, with inflation “more or less” under control and depending on how the new fiscal framework is formatted, there will be room for a drop in interest rates.

For XP Investimentos, the event in the US contributed to strengthen bets that interest rates could be cut sooner. The consultancy, however, points out that there are still doubts regarding the future macroeconomic policy.

“Brazil still has implicit risks, such as the tax issue. We are an emerging economy and highly indebted”, says Charo Alves, specialist at Valor Investimentos.

The scenario in the US

Warren Investimentos sees more direct and immediate consequences from the collapse of SVB. The main one concerns the rate at which the Fed is raising interest rates.

At the beginning of last week, the market had revised its expectations for a greater increase, of 0.5 percentage points, in the next meeting of the North American Central Bank, on the 22nd. Now, the market started to project an increase of 0.25 percentage point and interest rate cuts from July.

“This change in expectations illustrates the difficulty of the Fed in executing a mandate where inflation needs to be fought, at the same time that the labor market should be in conditions of full employment (and the banking system stable)”, points out a Warren report. .

Inflation remains under pressure in the United States. It closed at 6% in the 12 months ending in February. And the labor market remains heated, which makes it difficult for inflation to retreat. In February, 311,000 non-agricultural jobs were created, well above the market consensus of 205,000.

XP Investimentos points out that, if it weren’t for the turbulence in the American banking system, the data could force an increase of up to half a percentage point in American interest rates. “However, concerns over the stability of the financial system are likely to take precedence, forcing the Fed to adopt a more cautious approach in its March decision,” analysts note in a report.

According to the chief economist at C6 Bank, Felipe Salles, the degree of uncertainty has increased significantly, and when this happens it is natural for central banks to opt for less sudden movements, thus gaining time to acquire more information.

“The regulatory measures adopted so far should be enough to contain the financial crisis and, therefore, we maintain the view that the Fed should keep interest rates at a high level for a long time. However, if the financial crisis worsens, there is indeed the possibility that the Fed will respond with cuts in interest rates”, says Salles.

The chief economist at Suno Research, Gustavo Sung, considers that the situation for the Fed is complicated, and that it is still early to understand the dimension of the problems involving the SVB on the American financial system. “At the same time, the battle against inflation continues and we don’t think this is the time to loosen up.”

The impacts in Brazil

If, on the one hand, it can contribute to an early drop in interest rates, on the other hand, the collapse of banks in the US can harm Brazil in other ways.

Fibra bank assesses that agents tend to compare the collapse of the SVB with Brazilian retail companies that have also had balance sheet problems due to the high level of interest rates.

Salles, from C6 Bank, states that this greater degree of uncertainty, caused by problems in the US financial system, affects the Brazilian economy through two channels:

• the increase in investors’ risk aversion causes them to start looking for safer assets, such as US Treasury bonds, which tends to provoke the devaluation of currencies of emerging countries against the dollar;
• Greater uncertainty tends to make economic agents postpone consumption and investment decisions, with a negative impact on economic growth.

He also highlights the possibility of a reduction in global growth. In January, the International Monetary Fund (IMF) projected an expansion of 2.9% for 2023. “This has a negative impact on commodity prices. These effects may lead to lower growth in Brazil, but it is still too early to talk about magnitudes.”

Genial Investimentos assesses that the bankruptcy of SVB could tighten global financial conditions and aggravate the restriction of credit supply that followed the episode of the Americanas crisis. It could also influence a strong restriction on economic activity in Brazil.

Analysts at the brokerage point out that, should this occur, there may be a more pronounced deceleration in the inflation rate, even with the adoption, by the government of Luiz Inácio Lula da Silva (PT), of a more expansionist fiscal policy.

“This tightening in global financial conditions, combined with the expectation that the new fiscal framework will be announced next week, led most investors to price drops in the Selic rate in the second half of 2023, despite the signs of acceleration in core inflation shown in the IPCA since the end of 2022”, highlights Eduardo Nishio, head of research at Genial Investimentos.

Analyst André Valério, from Inter bank, points out that the tighter scenario also changes the balance of inflation risks. “The Copom may indicate at its next meeting that the start of interest rate cuts may be brought forward”, he says.

According to him, the additional tightening of credit, which is also observed in the local scenario, should contribute to a greater than expected drop in activity, accelerating the process of falling inflation from now on.