(Bloomberg) -- A central bank statement that underscored friction within the board tainted the pricing of Brazil’s swap curve, which is showing fewer cuts than traders and analysts think it should.

Policymakers’ decision to lower the country’s benchmark rate by 25 basis points to 10.5% last week met most expectations, but the accompanying statement — which showed a four-to-five split on the vote, and tried to cater to both dovish and hawkish arguments — created so much unease that the local swap curve reacted as if a major surprise had happened. 

All four officials who voted in favor of a steeper cut were appointed by President Luiz Inacio Lula da Silva, signaling to markets that the central bank’s strong commitment to fighting inflation may waver once Governor Roberto Campos Neto steps down later this year. As a result, the belly and long-end of the curve steepened with long maturities rising. Equally eye-catching was that stops — with traders all rushing to cut risks — prevented short-term DI contracts from declining.

The result is a curve that prices in only 13 basis points in extra cuts in this cycle, showing traders are unwilling to bet on a lower Selic rate even though most think the central bank will keep cutting borrowing costs. Elevated uncertainty abroad, especially with the murky path of US monetary policy, prevents them from opening extra receiving positions, which benefit from a decline in swap rates. Any hint of dovishness from the Federal Reserve may be enough to encourage traders to reshape the short-maturing swaps. 

“I do believe in the possibility that Brazil’s central bank can cut rates in the second half, if we get some help from US inflation,” said Rafael Ihara, chief economist at Meraki Capital.

Fiscal risk triggered by the change of Brazil’s 2025 fiscal target and now the difficulty in estimating the impact from extra expenses with aid to Rio Grande do Sul state amid deadly floods are also mentioned by traders as reasons for caution. 

Read More: Brazil Analysts Lift Rate Bets as Central Bank Splits on Policy

Still, economists are skeptical with the idea of a terminal Selic rate above 10.25%, as current prices show, because inflation has been converging to target and even core CPI is now more benign. April inflation data released Friday came in at 3.69%, already well within the central bank’s 1.5-4.5% target range. 

Brazil’s central bank has space to lower rates “beyond what is priced in,” JPMorgan strategists including Luis Oganes wrote in a note. Mexico, which kept rates unchanged on Thursday, also has room to cut further, they added. 

“As the dust settles around Fed expectations and currencies recover, we do not think that market pricing for end-of-cycle real rates above 6% in both countries is justified,” they said. 

Traders will now turn to minutes from the latest central bank decision, which will be released Tuesday, for explanations on why the statement was so full of hawkish remarks if almost half of the policymakers voted for a bigger rate cut. Failing to explain it make keep swap rates under pressure.

--With assistance from Giovanna Bellotti Azevedo and Vinícius Andrade.

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