Currency has been losing ground against the dollar, in its deepest plunge since January 2022; short-term interest rates soar with worsening exchange rate
07/02/2024
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Otavio Oliveira da Silva — Foto: Carol Carquejeiro/Valor
The perception that risks to the government accounts’ track have not diminished, coupled with an international scenario of high pressure on emerging markets due to rising yields of U.S. Treasuries, led to continued stress on local assets on Monday. In this context, the foreign exchange rate rose significantly, closing at R$5.65 per dollar, the highest level since January 2022. The depreciation of the Brazilian currency has pushed the market to price in a 125-basis-point hike in the Selic policy rate this year.
Recent days have seen a continuous deterioration in assets. Amid concerns over the government’s economic policy and the sense that politicians lack urgency in addressing fiscal issues, risk premiums on assets have been increasing rapidly.
Finance Minister Fernando Haddad attributed the weakening of the real to “communication noise” and said the government needs to better communicate the results achieved in the economy. Asked if it was time for the Central Bank to intervene in the exchange rate, he said that it is a matter for the monetary authority, “and they know when and how to do it.”
After the foreign exchange rate ended the first half of the year with an appreciation of more than 15%, there was an expectation that Friday’s stress was linked to the end of the semester, due to position adjustments and the formation of the end-of-month Ptax (an exchange rate calculated during the day by the Central Bank of Brazil). Monday’s session challenged that view.
According to Otávio Oliveira da Silva, treasury manager at Daycoval, the question to be answered is where the real crash will end. “Now we will be testing levels. If this speculative scenario testing continues, the Central Bank might eventually step in to calm the market. It’s hard to pinpoint when this will happen, though.”
In his view, the market struggles to find a feasible level that aligns with expectations. “For now, there is caution, and caution in a local uncertainty environment often translates into buying dollars.”
The pressure from the exchange rate spread to the futures interest rate market. Thus, the initial part of the yield curve, more sensitive to monetary policy prospects, faced strong upward pressure.
By the end of the day, the rate on the Interbank Deposit (DI) contract for January 2025 rose to 10.835% from 10.735% in the previous adjustment, while the rate for January 2026 DI increased to 11.77% from 11.55%.
In this context of accelerated depreciation of local assets, the market is now working with a Selic rate above 11.75% per year by the end of 2024—which would mean the Central Bank raising the Selic rate by 125 basis points by December. In the COPOM digital options market, agents increased their bets on an interest rate hike at the July meeting. On Monday, the probability of a 25-basis-points increase rose to 10% from 3%. The probability of a 50-basis-point rise jumped to 15% from 8%, and the likelihood of maintaining the rate fell to 71% from 85%.
“It was a day to stop and revisit the Central Bank’s recent communications. This is not our baseline scenario yet, but the questions need to be asked. We still have almost 20 working days until the next COPOM meeting, which is almost long-term in Brazil, but if the meeting were tomorrow, I believe the Central Bank would have to open up to the possibility of raising interest rates. Initially, I think the authority would communicate that the risk balance has become asymmetrical, which would be the first step towards a rate hike,” said Daniel Cunha, chief strategist at BGC Liquidez.
In his view, July 22, when the National Treasury announces the May-June Evaluation Report, will be crucial to understand the government’s commitment to the spending track and the fiscal framework. “The expectation is that there will be a spending freeze of around R$20 billion. It remains to be seen whether the political reality will allow this to happen, but there is growing pressure for this. This market discomfort is likely to persist until there is some trend reversal in the fiscal component,” said Mr. Cunha.
Decoupled from other local assets, the Ibovespa, Brazil’s benchmark stock index, closed the day higher, primarily supported by exporting companies that benefit from the weakened real. However, the local currency also exerted negative pressure as it affected the yield curve and, consequently, interest rate-sensitive companies. By the end of the day, the index rose by 0.65% to 124,718 points.
According to BTG Pactual analysts, the deterioration of local assets can be attributed to what they believe is a crisis of fiscal and monetary confidence. “The unanimous COPOM decision may have restored some confidence, but a full recovery is likely only after the new Central Bank president is appointed. On the fiscal side, we expect the government to announce a spending freeze in July, but structural changes are only expected after the municipal elections.”
Given the pressure from the weakened real, operators have been debating whether the Central Bank should intervene in the exchange market to ease the buying pressure on the U.S. dollar.
Mr. Cunha, from BGC Liquidez, believes that this discussion is secondary at the moment. “Using foreign exchange intervention as an economic policy tool is something we have moved past. It could happen in the event of transactional market dysfunction, and no one maps this better than the Central Bank’s exchange desk. The COPOM members themselves have denied this possibility. This is not the central problem facing local assets.”
B3 data once again showed an increase in the level of foreign bets against the real. The long position in the dollar is close to $82 billion, although some end-of-month adjustments may correct this value. On the other hand, local investors increased their short position in the dollar to $7.5 billion, which may also be adjusted due to the turn of the month.
*Por Arthur Cagliari, Gabriel Roca, Matheus Prado, Victor Rezende — São Paulo
Source: Valor International