Brazil's Surprise Rate Cut

What is Brazil seeing that we’re not aware of?  If you’re not pondering that this morning, then you may want to turn your investments over to someone else – yes, it is that important of a development…

From the WSJ:

SÃO PAULO, Brazil—Brazil slashed its overnight lending rate in a surprise move Wednesday that is likely to spur questions about the government’s commitment to fighting inflation—as well as the independence of its central bank.

Brazil’s central bank cut the overnight rate by half a percentage point to 12%, still among the highest rates in the world. In a statement, the central bank said weakening economies in the U.S. and Europe would take pressure off Brazilian inflation, reducing the need for its high rates.

There’s also talk that the cuts come at a time where the Brazilian Real currency is pressuring local manufacturers (it is up almost 50% since 2009).  I’m not sure that I believe that this was the only or even primary reason for a cut.

I also don’t believe that this cut has anything to do with US or European deflation taking pressure off of prices, I think it has more to do with weakening demand from Brazil’s number one minerals n’ materials customer, China.

Look at a chart of copper, look at crude.  Look at the Chinese small caps that trade in Hong Kong ($ECNS or $HAO offer a window) and are highly sensitive to early-cycle demand fluctuation.  China’s been tightening reserve requirements, curbing lending and raising rates using every tool at their disposal short of executing real estate developers live on CCTV.  At a certain point, this had to be felt by the exporters selling materials into China -and maybe that time is at hand.

I find Brazil to be one of the cleanest growth stories on the planet, a country with capital reserves rather than deficits and one of the few EM nations where they’ve successfully managed to develop their own internal demand.  China and India would eat their hearts out to achieve the dynamism of what Brazil has happening in its towns and cities with over 100 million people considered “middle class”.

But Brazil is still very much a China play in my view; a glance at the country index ETF ($EWZ) tells you all you need to know – it is dominated by materials exporters and not consumer companies other than banks.

Granted, much of this burgeoning thesis is speculation, we have yet to see demand for materials truly taper off in the data.  But after months of raising rates in Brazil, the central bank’s about-face demands that we pay attention.