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The 14.86% drop of the dollar against the real this year leaves no doubt that the market has been putting in prices the expressive interest differential between Brazil and the United States, which is expected to remain at high levels.
Although the Federal Reserve (Fed) has started a process of monetary tightening and now indicates a possible acceleration of the pace of interest rate increase, the Selic policy interest rate in double digits and still on an upward trajectory guarantees the exchange rate the possibility of the real to remain at more appreciated levels in the short term — although risks to this scenario remain on the radar.
In just one year, the Selic abandoned the historic low of 2% and is now at 11.75%. At the same time, in the United States, interest rates are in the range between 0.25% and 0.5%. And even in the real interest rate universe, the difference between the two countries’ monetary policy is quite high. While the real interest rate expected for one year in the U.S. is negative around 4%, the Brazilian real rate has levels around 7%.
And it is based on this context that the real appreciates against the dollar. Higher interest rates in Brazil have favored strategies in which investors raise funds abroad at lower rates and invest money in the country, known as carry trade. Last week alone, the dollar dropped 5.37% against the real and ended Friday’s trading session at R$4.7466, the lowest level since March 11, 2020.
“I can’t say I’m surprised. I’ve been waiting for this movement since the end of last year,” says Gustavo Menezes, macro manager at AZ Quest with a focus on foreign exchange. He notes that, with the Selic at 2% in mid-2020, the interest rate differential was “completely displaced”. “As we carried out the normalization of interest rates, there was no immediate effect because inflation rose very strongly and, thus, we were not able to practice a positive real interest rate. Now, the adjustment is being made and, looking ahead, we have a very positive real interest rate.”
Mr. Menezes notes that, even if the inflationary scenario remains challenging, the real interest rate should remain at high levels in Brazil, which maintains the perspective that the exchange rate appreciation may have even more space ahead. “At the same time, our pair, the dollar, has a very negative real interest rate, despite the pricing of interest rate hikes on the American curve. It’s as if they had to control inflation in the circumstances that we lived through last year,” he says.
The intensity of appreciation of the real against the dollar has been surprising. In the highs of the year, the dollar reached R$ 5.7245. “It’s an expressive movement, which seemed dammed up. The exchange rate has come a long way and there is still room to appreciate, but perhaps not to the same magnitude. For now, we don’t see room for [appreciation of the real] to stop,” he says.
From an “ugly duckling”, the real showed a stronger performance than most other emerging market currencies. Year-to-date, the dollar accumulates a drop of 2.26% against the Mexican peso; of 7.64% in relation to the Colombian peso; 8.53% against the Chilean peso; and 8.75% compared to the South African rand.
“The stars have aligned and fundamentals are justifying the lower price. It’s a pretty big move and all factors are in its favour”, says Daniel Tatsumi, currency manager at ACE Capital. In addition to the interest rate differential, commodity prices, whose rise proved to be quite expressive, especially after the start of the war in Ukraine, have also been influencing the real appreciation against the dollar.
In addition to commodities and interest in favor of a more appreciated exchange rate, the growth differential is starting to show more positive signs, which provides additional support for the appreciation of the real. “We expected a contraction of about 0.5% in GDP, but we revised it and now we see a number closer to [growth of] 1%. And, with the interest rate differential, the exchange rate movement has more to go,” says Mr. Tatsumi.
ACE’s view is even translated into long positions in reais, that is, bets that the Brazilian currency will further appreciate. “When we looked at what would make the currency better, we checked everything. Terms of trade, growth, interest differential and even the taxes, with a super positive collection.”
When looking at slightly longer terms, market economists opt for a slightly more cautious tone regarding the future behavior of the exchange rate. However, in recent days, in the wake of the more positive view of market agents with the real, exchange rate estimates have also been revised.
Itaú Unibanco, for example, cut its average exchange rate forecast to R$5.25 per dollar from R$5.54 per dollar, as it expects the real appreciation window to last longer than previously expected. In relation to the end of the year, the bank kept the dollar forecast unchanged at R$ 5.50.
“The main driver is the Selic, which has been rising throughout last year and before most other emerging markets. This, of course, helps the currency to attract capital flows to Brazil. And the flow of dollars to Brazil has been stronger,” observes economist Julia Gottlieb, with Itaú.
Data released on Friday by the Central Bank show that, from the beginning of the year to March 18, the foreign exchange flow had a net inflow of $9.446 billion. The result already exceeds the positive balance for the entire year of 2021 ($6.134 billion).
Bank of America’s strategists Claudio Irigoyen and Christian Gonzalez Rojas maintain an “optimistic” bias with the real, although they emphasize that political discussions can affect the behavior of the exchange rate as the elections approach. Strategists expect the dollar to end the first half at R$4.90 and to close the year at R$5.25. Before, BofA’s expectation was that the American currency could end 2022 at R$5.30.
In addition to factors such as the interest rate differential and the terms of trade, JGP’s chief economist Fernando Rocha, draws attention to the fact that the universe of emerging markets is relatively small and has been reduced even further. “Markets with depth are few.”
Mr. Rocha recalls that the conflict hit Eastern Europe and Russia hard and points out that Turkey has faced a difficult environment, with capital control measures. “Brazil is physically far from the conflict, it is a producer of food, iron ore and has high interest rates. When it all comes together, we are attractive,” he says.
For him, the flow is what may determine the direction of the exchange rate. “The interest rate will remain high at least throughout the year and Brazil is a commodity producer. It could be that the flow continues and the exchange rate gets even lower,” he says. For him, the dollar may fall to levels between R$4.20 and R$4.30 depending on the flow. “Remuneration is so good that we are starting to move in that direction [of appreciation of the real].”
Mr. Rocha believes that the intensity of the Fed’s monetary tightening process may also interfere with the exchange rate dynamics ahead. In addition, he cites an internal JGP study that, in general, the dollar weakens when the Fed starts to raise rates and only begins to strengthen at the end of the cycle, and then U.S. fixed income serves as a factor of capital attraction. “If the Fed starts to make a very strong pace, it can change the balance a little bit. But, so far, the interest rate differential remains very favorable to Brazil,” says the economist.
Source: Valor International