Could Brazil see the first interest rate cut since 2012 in October?

With the Banco Central do Brasil’s benchmark Selic interest rate at 14.25% there’s certainly plenty of room.

And even though the country’s politics are a total mess (nobody was impeached today and no president or former president was indicted today) and the economy is sputtering, Brazilian stocks have moved up strongly in anticipation of the central bank’s move.

An unexpected drop in inflation during the mid-month readings is the latest positive indicator. (Twelve month inflation fell to 8.78%, the lowest 12-month rate since May 2015.) In their latest projections economists have reduced their expectations for inflation in 2016 to 7.25% (from 7.34%) and to 5.07% in 2017 (from 5.12%). That has led projections for the Selic rate to fall to 13.25% by the end of 2016.

The first chance for the central bank to cut interest rates will come at its October meeting. The bank has said it is monitoring the economy to see if it can cut interest rates to help revive Brazil’s economy. The economy is forecast by economists to grow by just 1.3% in 2017.

An October interest rate cut by itself is already priced into Brazilian financial assets. Swaps contracts for interest rates in January have tumbled to price in rates of 12.25%.

With the U.S. Federal Reserve likely to raise interest rates in December, the Brazilian markets with good news already anticipated could be in for a patch of scary volatility if 1) the Banco Central doesn’t cut in October, and 2) if an increase in U.S. interest rates knocks emerging market assets and currencies into a short term decline.

Frankly with the iShares MSCI Brazil ETF up 62.76% year to date, I’d like to see an actual cut in rates from the central bank before I bought into this rally. (Any disappointment would be severe but probably temporary and I’d use it to buy. If the central bank does cut interest rates and validate the optimism, I’d look to buy as well. I’m just trying not to gamble on the risky short term.)

What am I looking at if the Brazilian central bank does cut interest rates?

I’d focus on the domestic economy with an emphasis on well run banks and consumer businesses with big exposure to the interest rate cycle. To increase that emphasis beyond what the ETF provides (with its big positions in commodity exporters) I’d look to individual stocks in these two sectors.

In the former banking group, I’ve owned Itau Unibanco (ITUB) in my Jubak Picks portfolio since October 31, 2014 and I’d continue to hold and build positions on any negative surprise in October. The New York traded ADRs of Itau Unibanco are up 62.76% for 2016 as of the close on September 26. My position in the ADRs is still down 17.98% since I added them to the portfolio in October 2014. Which just shows you how low the bottom was. The ADRs, which closed at $11 on September 26, traded at $6.14 on February 26. In news of the last few days Itau Unibanco is in talks with Citigroup (C) to buy that bank’s Brazilian consumer business as a part of the retreat by big U.S. banks from some of their riskier markets.

Another choice with more of a consumer emphasis but with still a big financial angle would be Latin American rental car giant Localiza Rent a Car (RENT3.BZ in Sao Paulo or LZRFY over the counter in the United States.) Localiza makes a considerable part of its revenue from selling used cars from its fleet–and that business has been hit hard by the rise in interest rates. With Localiza you have the option of Brazilian shares with their direct exposure to the Brazilian real, or U.S. over the counter shares with a lesser exposure to the real. Recently the real has been one of the world’s best performing currencies–14.25% interest does attract interest and cash. I’d wager that an increase in U.S. interest rates modest as it is likely to be and a cut in Brazilian rates will take a bit of starch out of the real but I’m not looking for a big dip in the currency since the economic situation would have to be improving before the Banco Central cut interest rates.

Big commodity exporters such as iron ore miner Vale (VALE) fall further down my list because they remain exposed to demand in the global (and Chinese) economies.