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Analysis: Exchange rate caught between external factors and fiscal risks

Brazilian currency started weakening against the dollar again, following wave of appreciation that took it to R$5.70 from R$6.18 in late 2024

02/25/2025

The dollar’s exchange rate to the real had seen a significant drop at the start of this year, averaging R$5.70 last week from R$6.18 at the end of 2024. Now it’s back up at R$5.80. What exactly weakened the greenback and why is it rising again?

The Central Bank’s analysis indicates the dollar’s exchange rate has been reacting mainly domestic fiscal news, American economic policy developments, and interest rate spreads, according to the minutes from the latest meeting of its Monetary Policy Committee (Copom).

It appears that the real’s straightening against the real until last week was linked to more favorable external conditions. The weakening yesterday and today coincides with news suggesting that the Lula administration may expand fiscal and credit policies to prevent a sharper economic downturn.

Estimates from economists reveal conflicting explanations for the dollar’s decline until last week. Bradesco released a study attributing the weakening dollar to a softening of risks connected to domestic factors in Brazil.

Meanwhile, economist Livio Ribeiro, a partner with consultancy BRCG and researcher at the Brazilian Institute of Economics at Fundação Getulio Vargas (FGV Ibre), ran his exchange model at the request of Valor and concluded that the dollar weakened against the real solely due to external factors.

The Central Bank believes the primary force behind the real’s appreciation originated from abroad. Monetary Policy Director Nilton David, himself a currency expert, stated at a Bradesco event on February 21 that understanding the exchange rate’s dynamics requires examining what is affecting the real, not just the dollar.

“In December, we witnessed a high level of uncertainty emerging from all sides, which caused significant currency fluctuations,” Mr. David said. “In fact, the dollar moved more than other currencies, and some currencies ended up having higher betas.”

As explained by the Central Bank director, beta measures how much an asset’s price–in this case, the dollar–moves when a benchmark price changes. For instance, when Brazilian stocks fall some may decline more due to greater sensitivity to overall market fluctuations.

According to him, as uncertainty decreased, prices adjusted accordingly. “This process wasn’t exclusive to Brazil,” he said at the Bradesco event. “In fact, I don’t believe it was Brazil. The real pivot was abroad. Of course, each country has its idiosyncrasies that might amplify it or not.”

Bradesco, in a study released last week, noted that up until February 17 of this year “slightly over 80% of the Brazilian currency’s appreciation was driven by domestic factors.”

To reach this conclusion, the study analyzes the evolution of various factors that can influence the exchange rate, such as the prices of exported and imported goods and the interest rate spread between the U.S. and Brazil.

However, defining what constitutes an internal factor versus external factors that affect the risk appetite for Brazil is an artform. It could be that the real benefited from a lower risk perception by foreign investors. Mr. David’s argument is that volatility has decreased since Donald Trump’s inauguration, and volatility is measure of. It could also be that the evolution of Brazilian domestic issues made the country less risky.

To differentiate between these, Bradesco’s economists examine the behavior of currencies from other emerging countries affected by foreign investor risk perception.

The choice of this group of countries is a crucial detail, as the selected group can influence the results. Bradesco used South Africa, Chile, Croatia, Hungary, Indonesia, Mexico, Peru, Poland, Thailand, and Turkey.

Mr. Ribeiro calculated for the period from December 30 to February 17. During this period, various factors acted to lower the dollar against the real. Terms of trade–that is, the prices of our exports–rose by 5.2%, an emerging market risk perception indicator fell by 0.28%, and the index measuring the dollar’s strength against the rest of the world decreased by 1.4%.

However, the indicator which experienced a steep drop of 14.4% to 273 basis points was Brazil’s risk as measured by the credit-default swaps (CDS). When distinguishing domestic from external factors, there is an important difference. According to Mr. Ribeiro’s calculations, of the 7.5% fall of the dollar against the real during the period, 8.39 percentage points were due to external factors.

Domestic factors actually hindered the real, exerting an upward pressure of 0.49 percentage points. During the period, the interest rate spread between the U.S. and Brazil decreased, creating an upward pressure of 0.37 percentage points.

Since Monday, February 24, the market appears to be driven by domestic factors. This morning, February 25, the real is the weakest currency among 33 emerging market countries. It will take a few more days for this to be confirmed by economic models, which require more data to for more precise answers.

*By Alex Ribeiro, Valor — São Paulo

Source: Valor International

https://valorinternational.globo.com/
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Central Bank indicates greater concern over Lula’s fiscal policy

In face of fiscal risks, Copom maintains key interest rate Selic at 13.75%

12/08/2022

Central Bank's building in Brasília — Foto: Reprodução/Facebook

Central Bank’s building in Brasília — Foto: Reprodução/Facebook

Central Bank’s Monetary Policy Committee (Copom) kept intact the key interest rate Selic at 13.75% per year and its monetary policy message that foresees the maintenance of the rate at high levels for a sufficiently prolonged period.

Nevertheless, it intensified the tightening a little bit, by confirming at least a part of the financial market’s expectations that the current interest rate level in the country should be higher, due to fiscal uncertainties brought by President-elect Luiz Inácio Lula da Silva’s fiscal policy.

On Wednesday, the Copom found in its models an inflation rate of 3.3% for the 12-month period through June 2023. The percentage did not change much from the previous meeting’s estimate of 3.2% in October.

But this time the Central Bank uses in its projection a slightly higher interest rate path in the second half of 2023. In October, the assumption was that interest rates would start to fall in June, reaching 11.25% a year by the end of next year.

Now, the assumption is that interest rates will only fall in August, ending 2023 at 11.75% per year. That is, over the second half of 2023, the interest rates used in the projection are about 50 basis points higher.

The Central Bank uses, in its models, the trajectory for the Selic rate forecast by the market. Since all the fiscal uncertainty began with the strong break of the spending cap, economic analysts started to forecast slightly higher interest rates.

On Wednesday, with its projection, the Central Bank sent a message: the analysts are right in putting a little more interest rates on the Focus, the Central Bank’s weekly survey with analysts. If the interest rate cut were to start in June 2023, as previously expected, the projected inflation would probably be a bit higher, and further away from the target. The Copom is targeting an inflation rate of 3.125% for the 12-month period through June 2023, considering an average between the goals set for next year (3.25%) and the following year (3%).

For the time being, the Copom has confirmed only a little of the additional dose of interest rates that the market has incorporated. It has not gone as far as to legitimate all the huge risk premiums that are in the interest rate curve traded in the market, which has suffered a strong increase.

But, in a way, this upswing in market interest rates is entering into the Central Bank’s estimates, as it causes a strong deterioration in financial conditions.

This more hostile environment throws the economy down and widens the economic slack somewhat. But it does not necessarily slows down inflation, because the effect of fiscal uncertainty may prove to be stronger.

At the same time that it is incorporating some of the damage caused by fiscal uncertainty, the Copom is trying to maintain a degree of serenity, apparently so as not to worsen a picture that is complicated enough.

The Copom raised its inflation projection, but not too much, so as not to corroborate stronger interest rate hikes. Also, it stopped short from saying that its balance of risks for inflation has become asymmetric, tilting to the negative side, which could also require an even higher Selic rate.

The Copom sent the message that depending on how fiscal policy evolves, it may have to act. It referred to the “high” uncertainty in its balance of risks. And, although it preached serenity in the evaluation of fiscal policy, it said it will closely monitor how it will affect the foreign exchange rate and inflation expectations going forward.

*By Alex Ribeiro — São Paulo

Source: Valor International

https://valorinternational.globo.com/
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Analysis: Should Central Bank reassess fiscal risks?

Questions emerged after federal government’s decision to undermine fiscal anchor to hold fuel prices down

06/08/2022

Central Bank’s building in Brasília — Foto: Divulgação/Rodrigo Oliveira/Caixa Econômica Federal

Central Bank’s building in Brasília — Foto: Divulgação/Rodrigo Oliveira/Caixa Econômica Federal

Market analysts have begun to discuss whether the Central Bank’s Monetary Policy Committee (Copom) should reassess its balance of risks to inflation after the government unveiled the intention to go over the spending cap to reduce fuel prices in this election year.

In its last two meetings, the Copom became less downbeat about the fiscal situation. As a result, the danger that the lack of control of public accounts could lead to higher inflation than projected for next year took a back seat in its monetary policy decisions.

In March, the policymakers concluded that the balance of risks to inflation was less tilted to the negative side, arguing that current fiscal data were better than expected and that the foreign exchange rate and inflation expectations already reflect most risks. In May, for similar reasons, they saw risks balanced.

The rebalancing of risks was at odds with the view of most of the market. The pre-Copom survey made on the eve of the meeting in March showed that 50% of economic analysts evaluated that the fiscal situation had worsened at that moment, compared with 22% who said it had improved. The remaining 28% thought there had been no change.

Due to the strike by Central Bank employees, the results of the May pre-Copom survey were not released. The Central Bank has sent a new survey to the market to gauge opinions for its meeting next week.

In its official documents, the Central Bank has asked the financial market for “serenity” in assessing fiscal risks in an environment it considers to be one of great uncertainty. Many, however, say that the improvement in short-term data is undermined by the destruction of the fiscal anchor.

The exchange rate is again under pressure as the deterioration of the fiscal situation became clear after a new attempt by the federal government to go over the spending cap, the rule that limits public spending to the previous year’s inflation. Above all, such deterioration caused long-term interest rates to rise, which means that investors require a higher premium to buy National Treasury bonds.

A potential revision of the balance of risks would have implications for monetary policy. Currently, the Copom is managing interest rates with a view to meeting the 2023 inflation target. According to the most recent projection of the monetary authority, released in the May meeting, inflation is seen at 3.4% in 2023, above the 3.25% target for the year.

The market, however, already estimates inflation of 4.39% in 2023, after faster rates in April and May. The projections by the Central Bank may be revised upward as well.

If the Central Bank acknowledges the worsening of the balance of risks, making it asymmetric again, it would mean that the inflation expected by the policymakers would be even higher, since the chances of a higher-than-expected reading would be greater than of a lower-than-expected rate.

In theory, this would require even higher interest rates to bring inflation to the target within the relevant monetary policy horizon.

But many analysts are skeptical that the Central Bank will revise its balance of risks to inflation. The monetary authority has sent several messages that it is near the end of the monetary tightening cycle. In addition, considering that current inflation is rising more than expected, the Central Bank is unlikely to look for new reasons to raise interest rates even more.

* Alex Ribeiro — São Paulo

Source: Valor International

https://valorinternational.globo.com/
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