Brazil Should See More Rate Cuts

We highlight TAM (TAM - Analyst Report), AmBev (ABV - Analyst Report), Net Servicos (NETC - Analyst Report) and Sabesp (SBS - Analyst Report).

As we have been saying, the devaluation of the Brazilian real during the fourth quarter 2008 and first quarter 2009 was not sustainable. Since the beginning of the second quarter 2009 the Brazilian real has already gained 13% against the U.S. dollar and this movement is already creating some reaction in Brazil.

The Brazilian Government and export companies would like to prevent an appreciation of the real below BRL/US$ 2.00. This week, the Brazilian Central Bank has begun to act on the cash market buying US$.

We do not believe this strategy will work. During 2006, 2007 and the first half of 2008, the Central Bank has bought US$ -- accumulating over US$200 billion in reserves -- and the Brazilian real appreciated considerably against the US$. The trend was reversed just with the crisis in the fourth quarter 2008.

There is just one solution for the currency appreciation problem in Brazil: lowering interest rates. After three aggressive cuts this year current rates are at 10.25% per year -- still too high. We were expecting rates to reach 9% in the end of 2009.

We are beginning to wonder if our expectation is not too conservative. If the real is to be kept above BRL/US$ 2.00 in the following months, domestic rates should be reduced more aggressively. In such an economic environment, we continue to recommend companies focused on domestic demand, particularly the ones who would benefit from the currency appreciation. We like TAM (TAM - Analyst Report), AmBev (ABV - Analyst Report), Net Servicos (NETC - Analyst Report) and Sabesp (SBS - Analyst Report).