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Market is cautiously optimistic about Brazilian real

Since first round of election, local investors have increased bets on the Brazilian currency

10/10/2022

High interest rates in Brazil were already in the scenario, as was the perception that key interest rate Selic will remain unchanged over the coming months. But the results of the first round of elections improved expectations of market players for the foreign exchange rate. Caution still prevails as the U.S. dollar has gained ground around the world, but local investors have once again increased their bets on the real.

Data from B3 show that since the result of the first round was known local institutional investors increased their short positions on the U.S. dollar to $58.4 billion on Thursday from $54 billion on September 30, the last trading session before the first round. In other words, they sold $4.4 billion in the period.

The election of a more conservative Congress propped up Brazilian assets soon after the first round and dissipated part of the uncertainties in relation to the direction of fiscal policy in the next administration. Some asset management companies had already adopted a more optimistic view in relation to local markets before the election, and this bias has gained steam, at least in the short term.

“We have turned a little more positive on the real. The currency has fallen behind and investors focused on emerging markets doesn’t have much of an option. Brazil is becoming one of the few alternatives with a good price,” said Reinaldo Le Grazie, founding partner of Panamby Capital and a former director of the Brazilian Central Bank. Given the lack of investment options in large emerging markets and the more positive feeling after the first round of the general elections, the local exchange rate may be favored, at least in the short run, he said.

“The market saw the election result as a very good one. There was a fear of not having a runoff vote in the presidential election, which would be considered bad due to the lack of discussion about the direction of the economy. Now this debate is emerging. Besides this, the market liked the configuration of a more conservative Congress,” said Mr. Le Grazie.

Although Brazil’s fiscal situation remains unclear, he said, the asset management company has a more optimistic view on local assets at the moment and is more concerned with global markets. “It’s a slightly better scenario in a very difficult world. That looks good for the stock market. And, if the stock market moves forward, it is likely to take the currency with it.”

Gustavo Medeiros, Ashmore’s head of global research, had a very positive perspective for Brazilian assets even before the election. Now, by commenting on investments in Latin America, he said that “politics has been the main risk in the last few years.” He recalled that former President Luiz Inácio Lula da Silva (Workers’ Party, PT) and President Jair Bolsonaro (Liberal Party, PL), who are running in the second round, were already well known by the market, so there was no great surprise as for who the next president will be. “There are uncertainties, but they do not indicate a paradigm shift.”

Mr. Medeiros saw former Minister Henrique Meirelles’s nod as a “positive” development, as he is a free-market believer, and stressed that economists such as Arminio Fraga, Pérsio Arida and Edmar Bacha support Mr. Lula da Silva. “On the other hand, Bolsonaro is expected to keep a lean government policy, which was positive for the market,” he said.

According to Exchange B3, since the end of the first round, international investors have reduced their long dollar position by $3.7 billion, to $24.9 billion.

Ashmore remains positive on Brazilian assets. “With inflation coming under control now, more sustainable growth, and terms of trade more favorable for Brazil, there would need to be a very poorly management of the economic policy to hinder the recovery of local assets,” said Mr. Medeiros.

Kinea Investimentos has a similar view, and has made allocations in Brazilian assets rather than in international ones. “The picture of Brazil today against peers and developed countries is better. We have a primary surplus this year; the fiscal situation here is better than that of [Brazil’s] peers; the current account deficit is moderate and pretty much financed; and we are well advanced in the monetary policy cycle,” said Daniela Lima, Kinea’s economist for Brazil.

“The uncertainty today stems from who the next president will be,” she said. But, regardless of who is in office, “the incentives will be, at least at the beginning of the government, to have a more moderate fiscal agenda and a positive fiscal signal.” In Kinea’s monthly live-streaming event on hedge funds, Ms. Lima emphasized that Brazilian assets, in terms of valuation, are very attractive at the moment. Not coincidentally, the manager is long on the real and Brazil’s stock market, and holds short positions on inflation.

In this month’s letter, Kinea points out that the rationale for being long on the real “is a more proactive tactical view on Brazil, due to attractive interest rates, balanced external accounts, and our expectation that the next administration will have a reasonable fiscal stance at the beginning of its term.”

Although there is greater optimism with the real and other Brazilian assets, some market players still advocate greater caution with the currency. SulAmérica Investimentos, for example, has been trading the real in a more tactical way as there is still no good definition about the fiscal framework to be in effect as of 2023, against a backdrop of strong dollar abroad.

“We are living in a world of much greater uncertainty than we had before the pandemic,” said Alexandre Caldas da Cunha, senior manager of hedge funds at SulAmérica. “We think that if we have a better and more positive definition about how the economic guidelines of the new administration are going to be, whoever it may be, especially because the spending cap will change, there is potential for the real to appreciate. This, however, is not clear yet.”

He sees signs of improvement in the exchange rate, such as the rally seen in the trading session after the first round of the presidential elections. In just one day, the dollar lost more than 4% against the real. “But, at the current level of the dollar, considering the global scenario and the uncertainties here in Brazil, we don’t see great opportunities in the exchange rate at this moment,” he said.

Bruno Marques, a partner and manager of hedge funds at XP Asset Management, also believes that the exchange rate is not the best way to express a more constructive view of Brazil for the time being. During his monthly live-streamed event, Mr. Marques pointed out that the equilibrium exchange rate, which ranged between R$4.8 and R$4.9 to the dollar, has been converging to R$5.15. “We don’t see much of a premium in the exchange rate.”

*By Victor Rezende, Gabriel Roca — São Paulo

Source: Valor International

https://valorinternational.globo.com/
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Market expects benchmark interest rate to surge

The inflationary scenario already called for caution and indicated a great challenge ahead for the Central Bank. The concerns of market players, however, have increased as inflation has raised a red flag, with an even more persistent character, while the monetary authority has given signs that the end of the tightening cycle is near. The deterioration of the scenario continued to materialize in market projections: the escalation of inflation expectations continued and an increase in the Selic policy interest rate beyond June entered the debate strongly.

Between May 24 and 27, Valor consulted 101 financial institutions and consultant firms about projections for inflation and policy interest rates this year and in 2023. Since the last survey, published on May 12, the median of expectations for Brazil’s benchmark inflation index IPCA increased to 8.9% from 8.35% this year and to 4.5% from 4.2% in 2023.

Regarding the Selic rate, the median of the estimates remained at 13.25% at the end of this year but increased to 9.63% from 9.5% at the end of 2023. The simple arithmetic average of the projections for the Selic at the end of this year also rose, to 13.48% from 13.39%.

With the basic interest rate at 12.75%, the Central Bank has contracted a new increase in the Selic rate in the June meeting, at the same time that it has given increasingly clear signals that it wants to end the monetary tightening cycle that started in March 2021. Nevertheless, the monetary authority has started to adopt a more data-dependent strategy.

Part of the market has migrated to a scenario foreseeing a hike in August. Two weeks ago, 25% of the estimates indicated a rise in interest rates in August. In the current survey, this scenario is already defended by about 36% of the institutions.

Fernando Rocha — Foto: Leo Pinheiro/Valor

Fernando Rocha — Foto: Leo Pinheiro/Valor

“There is a desire to stop, but we still have very bad inflation. In every month, the [mid-month inflation index] IPCA-15 and the full IPCA have been surprising us negatively,” says Fernando Rocha, chief economist at JGP. He expects the Central Bank will try to end the cycle but will not succeed. That’s why JGP projects the Selic rate at 14.25% at the end of the cycle.

“I see the risk of the Central Bank stopping and inflation expectations getting even worse. If current inflation were a little better, showing signs of slowing down, I believe it [the monetary authority] would be more comfortable, but it is getting worse and spreading,” observes Mr. Rocha. The scenario projected by JGP is one of the most complex for disinflation in 2023, as it foresees the IPCA at 5.6% next year.

Brazil’s mid-month inflation index IPCA-15 for May scared the market about the dynamics of inflation. The acceleration of the cores raised the alarm among economists regarding scenarios of even more persistent inflation ahead.

“The IPCA-15 had a very bad quality indeed, really bad. The Central Bank, in fact, has already raised interest rates a lot, but we are afraid that it will end up stopping the cycle with an inflationary situation of this nature. This could further de-anchor expectations”, points out the chief economist at Truxt Investimentos, Arthur Carvalho, whose projection indicates the Selic at 13.75%.

He argues that it is better for the Central Bank to keep raising interest rates now in order not to run the risk of having to raise the Selic even more in the future due to the chance of further de-anchoring of expectations.

Mr. Carvalho notes that there has been a change in the monetary authority’s strategy, which has become more dependent on data. “Before, the Central Bank was very explicit and now it is no longer being so, in order to try to see if, as time goes by, it can get some evidence that the monetary policy is working. So the best thing right now is to slow down to buy time,” he argues.

Claudio Ferraz, chief economist for Brazil at BTG Pactual, is also attentive to the unfavorable surprise of the IPCA-15. “A highly disseminated inflation, with very high cores, is the kind of composition that leads one to reassess the short and medium-term scenario, impacting longer-term projections,” he says.

The prospect that the cycle of Selic hikes will end with the rate at 13.25% gained less clear features, in the economist’s view. “Although we expect a 50 basis points increase now in June, the risks are up. They have been growing in the sense that we might have another high in August,” he says.

Mr. Ferraz, however, says that clearer signs of an economic slowdown could prevent the Central Bank from extending monetary tightening into the second half of the year. “The debate could grow if the activity data in June and July start to show a sharper weakening. There is still a long period for the Central Bank to monitor economic indicators, but in that sense, it depends on the data.”

At least in the short term, economic activity has shown resilience, despite the tightening of monetary and financial conditions observed since the end of last year. “If demand proves more resilient than expected, the Central Bank’s job will become more difficult. However, we believe that due to the lag in the monetary policy action, of about nine months, most of the effect of the real interest rate tightening will be observed in the second half,” says Andressa Castro, chief economist at BNP Paribas Asset Management.

For her, it is not possible to draw hasty conclusions about the monetary policy action based on the positive surprises of recent months in activity. “In this sense, the main indicators to monitor will be the pace of consumption of excess savings, which has contributed to the resilience of demand, and the performance of the most credit-sensitive sectors, such as construction and discretionary consumption,” she emphasizes.

Ms. Castro, however, notes that if the gap between 2023 inflation expectations and the target continues to increase, it could generate additional pressures on the Central Bank. “According to our models, if expectations rise above 5%, a movement that is already starting to happen, it would be necessary to tighten the Selic more, entering the second half of the year, to avoid an even greater de-anchoring,” she says. For Ms. Castro, this scenario would increase the chances of the Selic approaching 14% — which is not in BNP Paribas Asset’s baseline scenario at the moment.

In fact, de-anchoring of expectations has proven to be even more pronounced. Of 99 estimates collected in Valor’s survey for the IPCA in 2023, 24 already indicate that inflation will end the next year above the target cap.

“There is no longer any discussion about the dangers of inflation spreading. This is already a fact,” says Dalton Gardiman, chief economist at Bradesco BBI. He points out that in his estimate of 8.5% for the IPCA in 2022, some effect of the reduction in sales tax ICMS on fuels and electricity is already considered.

However, there is a prospect of major disinflation next year, given the prospect that global economies — Brazil included — will lose traction in 2023. “The big theme and the biggest challenge in the year 2022 is inflation. I believe that this theme will become growth in 2023,” says Mr. Gardimam. Because of that, he projects stagnation of the economy next year and inflation at 4.5%.

(Anaïs Fernandes and Marta Watanabe contributed to this story)

Source: Valor International

https://valorinternational.globo.com

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Market already projects inflation at 7.5% by year end

Patricia Pereira — Foto: Leo Pinheiro/Valor
Patricia Pereira — Foto: Leo Pinheiro/Valor

The Brazilian monetary authority has been sailing in the dark for almost two weeks without the latest editions of the Focus survey, which collects the estimates of economic agents for several key indicators in the management of the country’s monetary policy, such as inflation (IPCA), activity (GDP), and interest rates (Selic). It does not mean, however, that market projections are not moving. Since the last Focus survey, released on March 28 and interrupted by a civil servants strike, the official inflation for March has frightened, the president of the Central Bank has reacted and the statistics agency IBGE has released the performance of the main sectors of the economy in February.

A survey carried out Wednesday by Valor with 74 financial and consulting firms shows a median projection for the variation of the country’s benchmark inflation index IPCA of 7.5% in 2022 and 4% in 2023. The lowest estimates are 6.5% for this year and 3.4% for next year, while the highest are 8.6% and 6%, respectively.

In the latest Central Bank bulletin, whose responses were collected on March 25, the median expectation for the IPCA was 6.9% in 2022 and 3.8% in 2023. The targets are 3.5% and 3.25%, respectively, with a tolerance of up to 5% and 4.75%, in that order. Valor’s survey is not directly comparable to Focus, which registers around 130 to 140 responses, but it helps to give a sense of direction.

“What led many people to revise [the inflation projection] recently was the IPCA of March, the biggest surprise in 20 years,” said João Fernandes, an economist at Quantitas, in reference to the monthly high of 1.62%. The median market expectation was 1.32%, according to Valor Data. “Before that, the revisions were just approaching the median, as some firms that had lower numbers raised their estimates. The data changed this dynamic. They all started to revise projections upwards”, Mr. Fernandes said. Quantitas forecasts inflation of 8.3% in 2022 and 4.3% in 2023.

Goods in general are to blame for current inflation, including the durable ones, like vehicles and electronics, and semi-durables, such as cleaning products, cosmetics and clothing, Mr. Fernandes said. The story, he says, is well known: the global lack of inputs, in the context of the pandemic, was in the process of normalizing, but ended up aggravated again by the war in Ukraine and the outbreak of Covid in China.

“Our biggest concern is basically with the inflation scenario. We experienced last year specific shocks that turned into generalized price hikes, and we had even more shocks on top of this already concerning picture. This is why we think that the IPCA will close the year at 8%, because inflationary pressures are very disseminated,” said Roberto Padovani, the chief economist at Banco BV.

These shocks will be more persistent than predicted, due for example to the secondary effects of inflation on fuels and other commodities, said Gustavo Arruda, head of research for Latin America at BNP Paribas. “When we do the math, we see that those risks are undersized.” He projects the IPCA at 8.5% this year and 4.5% next year.

In Brazil, Mr. Fernandes added, there is still a resilient labor market. “Even though we understand that a higher Selic will ease the pressure at some point, we see now labor costs gaining traction amid higher demand for in-person services. We saw the PMS [Monthly Services Survey] slowing down last month, but I think there will still be strong readings for three or four months.”

IBGE said this week that services fell 0.2% in February compared to January, seasonally adjusted, while the expanded retail market — which includes vehicles and construction materials and is what counts the most for the GDP — advanced 2%. Earlier this month, the institute said that industrial production had grown 0.7% in February.

Based on these indicators, the Central Bank would present Thursday its February Economic Activity Index (IBC-Br), which offers the market a barometer of the month’s activity, but the release is not expected to happen because of the strike. Valor Data’s survey with 27 analysts indicates a median increase of 0.4%.

Valor’s survey captured Wednesday a median projection for the GDP of 0.5% in 2022 and 1.2% in 2023, virtually the same as the Focus of April 28 (0.5% and 1.3%, respectively).

Another problem for inflation, according to economists, is the perception that inflation expectations are unanchored. “That leads to more persistent inflation. Even in sectors of the economy that are not directly affected by the conflict, just the perception that the cost of living is higher allows agents to pass on more price. Although we are a little blind because there has been no Focus survey, the dynamics of the daily price surveys show that inflation is not slowing down,” said Mr. Arruda, with BNP Paribas.

When “the regime in people’s minds” and the economy takes longer to deflate, the Central Bank “must try to ease the pass-through,” said Fernando Fenolio, the chief economist at WHG. The president of the monetary authority, Roberto Campos Neto, drew attention earlier this week when he acknowledged that the result of the IPCA in March was a surprise and said that “our inflation is very high.”

“The Selic rate today is our point of greatest uncertainty. We recently brought it to 12.75%, despite the math showing that it would need 13.5%, because the monetary authority made a point of affirming that 12.75% was enough. After the IPCA of March, Mr. Campos Neto opened the possibility of a stricter conduct, but we are still waiting for a more intense communication,” said Étore Sanchez, the chief economist at Ativa.

The survey for the Selic rate carried out by Valor is directly comparable to another one made by the newspaper in mid-March and showed no change in the projection of a median Selic rate of 13.25% at the end of the high cycle this year.

“The bar was high for the Selic to go above 12.75%, but it was only because of the Central Bank’s signaling, as on the inflation side the dynamics showed that prices were going to continue rising fast,” said Patricia Pereira, the chief fixed income strategist at MAG Investimentos. She revised her forecast for the Selic to 13.75% from 13.25% after Mr. Campos Neto’s remarks.

Some factors can help the Central Bank in its task. If the exchange rate remains below R$5 to the dollar, for example, this may translate into lower industrial prices, and the activity, as it gets weaker, would also contribute to a lower pass-through capacity, points Mr. Fenolio, with WHG.

The median of the exchange rate projections of the last Focus survey was R$5.25 at the end of 2022, while the one collected Wednesday by Valor indicates exactly R$5. Even so, it would be a more depreciated exchange rate than the current levels. “There doesn’t seem to be much more room for an appreciation of the real ahead. The United States will start to tighten interest rates, there is domestic uncertainty and commodities have already risen a lot at the peak,” said Ms. Pereira, with MAG.

Source: Valor International

https://valorinternational.globo.com

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High interest rates lead market to expect a more appreciated real

Fernando Rocha — Foto: Leo Pinheiro/Valor
Fernando Rocha — Foto: Leo Pinheiro/Valor

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

https://valorinternational.globo.com

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