Wall Street is betting that Brazil will accelerate its pace of adjustment

The main firms of Wall Street warned that the worsening fiscal outlook for Brazil is pressuring central bankers to accelerate their pace of adjustment and raise the interest rates more than expected next week.

JPMorgan Chase & Co., Goldman Sachs Group Inc, Credit Suisse Group AG and Morgan Stanley raised their forecasts for interest rates and expect Roberto Campos Neto to raise the benchmark Selic rate by at least 125 basis points on Wednesday to 7.5%. For their part, analysts at UBS BB and Barclays Plc expect a rise of 150 basis points.

Banks say higher rates will be needed to offset the inflationary pressure created by President Jair Bolsonaro’s promise to boost cash transfers to the poor, despite warnings that the government cannot afford it. To pay for the new aid, Brazil will have to seek a change to a spending cap rule that is seen by investors as one of the last anchors of fiscal stability for the developing nation.

Investors “reached a tipping point,” wrote Goldman Sachs analyst Alberto Ramos. The government’s efforts to boost cash transfers are eroding a key spending anchor, he noted.

Economy Minister Paulo Guedes, who lost four members of his team amid disagreements over the additional spending, defended the aid on Friday, saying Brazil’s fiscal framework has not changed. He also indicated that the central bank, which obtained formal autonomy earlier this year, cannot be left behind.

“If everything is increasing, then the focus should be on the central bank,” he said at a press conference with Bolsonaro on Friday.

Brazil’s monetary authority has been among the most aggressive in the world, raising rates from 425 basis points to 6.25% since March.

Inflation has skyrocketed above target for months in Latin America’s largest economy, driven by rising food and fuel prices. Consumer price inflation reached 10.25% in September. The central bank is targeting inflation at 3.75% this year and 3.5% next.

“If in the next 72 hours the Government and Congress do not commit to contain the additional cash transfers at around 30,000 million reais next year, the Copom could start a more aggressive adjustment cycle with a hike of at least 150 basic points”. Cassiana Fernández, JPMorgan’s chief economist for Brazil, wrote in a research note. Otherwise, they risk losing control over inflationary expectations as the currency depreciates, he added.