BRIC Interest Rates Fall – But Where’s the Stock Market Rally?
Brazil caught the market by surprise last week with the dovish talk by its central bankers on the inflation outlook that accompanied the 75-basis point cut to its key short-term lending rate. That cut brings the total reduction in the “Selic” rate to 3.5 percentage points and leaves interest rates at a near-record low of 9 percent.
The Latin American nation isn’t alone. Other BRIC nations are either cutting rates (India also acted last week) or taking other measures to make lending less expensive. For instance, China has been easing its reserve ratio requirements for banks, a move aimed at boosting liquidity and bank lending. As recently as last Wednesday, the country’s Xinhua news agency quoted an anonymous central bank official as saying that the People’s Bank of China is still focused on easing, in order to ensure a smooth landing for the Chinese economy.
Historically, when interest rates in emerging markets such as the BRIC nations decline, stock markets in those nations tend to rally and outperform their counterparts in the developed economies. As this week’s chart of the week shows, below, periods of falling interest rates in 2006-7 and again in 2009, have been followed by gains in equity markets, while rising rates in 2008 and again from 2010 through to mid-2011 have been accompanied by sluggish relative performance on the part of BRIC stocks.
The signs being sent by central bankers – like the anonymous individual quoted by Xinhua – are that the easing will continue. Brazilian central bankers also sent clear signals to the market that, all things being equal, they likely will continue to cut; they pooh-poohed the idea that there are any inflationary risks lurking and noted that outside pressures have instead tended to create a deflationary environment. Meanwhile, China still has plenty of room to make further cuts to the reserve ratio for banks (its reductions to date have been modest), although concerns regarding food price inflation may dictate the magnitude and timing of those moves.
Only time will tell whether these reductions are enough to overcome any remaining wariness on the part of stock market investors to allocate more to BRIC equities. The logic is clear: in periods of falling interest rates, equities become relatively more attractive from a valuation perspective. Perhaps investors are wary about how effective policy responses in India and China will be in ensuring that the economies of those countries continue to expand at relatively robust rates. Meanwhile, Brazil’s economy – once superheated – grew only 2.7% last year and policymakers have undertaken a range of measures, including tax cuts, to try to ensure that it manages to eke out the forecast 4% growth in GDP this year.
Logic and history argue in favor of a “catch-up” rally in BRIC equity prices and valuations, but the question remains whether investor psychology – and specifically fear – will prove more important than either of these.