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Believe It: Brazil Hikes Rates And ETFs Rise

May 30, 2013 1:22 pm
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Every central banker is lowering interest rates these days. Alright, that is slight hyperbole, but there is no denying there have been plenty of rate cuts lately and a fair amount have been seen in the developing world. Major emerging markets such as India, South Korea, Thailand and Turkey have recently lowered borrowing costs.

Brazil is not on that list. In fact, Latin America's largest economy has gone the other direction with a 50-basis point rate increase on Wednesday. Brazil's benchmark interest rate is now an almost unfathomable eight percent.

Interestingly, investors seem to approve of the news as the iShares MSCI Brazil Capped Index Fund (NYSE: EWZ) and the Market Vectors Brazil Small-Cap ETF (NYSE: BRF) are each higher by nearly one percent today. What makes the positive reaction to the rate increase news by EWZ and BRF all the more interesting is that the rate hike announcement arrived on the same day that Brazil reported year-over-year first-quarter GDP growth of just 1.95 percent. Simply put, that is not enough to compel investors to take on emerging markets risk when comparable levels of growth can be had in the U.S.

Heading into the start of trading Thursday, EWZ was down 6.3 percent year-to-date, a middling performance among the four major BRIC ETFs. That is good enough to be better than the comparable China and Russia ETFs and slightly worse than the WisdomTree India Earnings ETF (NYSE: EPI).

The 50-basis point increase shows the Brazilian central bank's resolve when it comes to fighting inflation as most economists expected just a 25-basis point increase. Brazilian inflation has already hit the high end of the desired target range this year, or 6.5 percent, and the inflation-fighting efforts come after Brazil spent much of last year trying to weaken the real to help exporters.

Those efforts may have paid off as the WisdomTree Brazilian Real ETF (NYSE: BZF) is down almost six percent in the past 90 days. However, high inflation and interest rates may see to it that the real does not stay suppressed for long.

To be sure, the rate cut has its fans. "We were positively surprised with this outcome as it signals that the Bank has become more focused on inflation and should act to re-anchor expectations," said a Barclays economist, according to Forbes.

Still, Brazil is in a tough spot. If not for a fairly low unemployment rate, though one that has been ticking higher, folks might be talking about stagflation in Brazil as the country has the low growth/high inflation part of the stagflation equation down pat.

As CNBC notes raising rates to quell inflation exacerbates another problem that Brazil's President Dilma Rouseff is trying to solve, that being Brazil's decrepit infrastructure. Rouseff has previously tried to jolt the economy through infrastructure largess, including a $66 billion spending program announced last August.

Worth noting is that the interest rate hike comes at a time when Brazil is scurrying to prepare for the 2014 World Cup. The EGShares Brazil Infrastructure ETF (NYSE: BRXX) joined EWZ and BRF in the green today, on strong volume no less, but it will be interesting to see how higher borrowing costs affect BRXX going forward.

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