Fed and BCB decisions define risks and capital flows for Brazil

CAUSE: : Amid a political crisis involving former President Bolsonaro and potential (and perhaps likely) new U.S. sanctions, we have two major interest rate decisions this week, the so-called "Super Wednesday." In the U.S., all signs point to the Fed cutting rates by 25 basis points to the 4.00%-4.25% range, responding to a milder inflation scenario alongside a cooling labor market. In Brazil, expectations are centered on the Selic rate being held at 15% p.a., as inflation remains above target and there are still questions regarding the actual impact of tariff policies on Brazilian prices. Consequently, the Central Bank has been categorical in its stance that our interest rates will remain at a high level, at least until the end of this year.

‍

CONSEQUENCE: The combination of U.S. rate cuts and the maintenance of the Selic at a high level is expected to have distinct effects on the markets. Abroad, the reduction in the Fed Funds rate tends to boost the relative attractiveness of emerging market assets, favoring capital inflows into countries like Brazil. However, this potential for foreign capital inflow may be partially offset by the domestic political environment, which remains marked by the crisis surrounding former President Bolsonaro and the risk of new U.S. sanctions. Furthermore, while keeping the Selic at 15% p.a. is important for anchoring inflation expectations, it keeps the cost of credit high and limits the recovery of domestic economic activity. In this context, the exchange rate trajectory is likely to remain sensitive to both international liquidity and the risk premium demanded by investors to hold Brazilian assets, making the coming months particularly challenging for balancing growth, inflation, and financial stability.

‍