Analysis: Brazil's real set to strengthen, not without a fight
RIO DE JANEIRO
RIO DE JANEIRO (Reuters) - A number of dull trading sessions in Brazil's foreign exchange market could prove to be just the proverbial calm before a storm.
The Brazilian real has barely budged since last Monday, when the country's central bank intervened in the market for the last time, once again preventing the currency from strengthening past the 2-per-dollar mark.
But the market lull may soon turn into a fierce fight between policymakers and investors, fueling trade disputes and potentially disrupting an incipient economic recovery in Brazil.
In a bid to support local industries, Brazil is ready to ramp up controls on money inflows resulting from easy monetary conditions in the developed world, Finance Minister Guido Mantega said last week.
A senior government official told Reuters that Brazil will defend the level of 2 reais per dollar "like a wall."
On the front line is the central bank, which may start purchasing dollars in the spot market when capital inflows grow larger, a second government official said. If that fails, the Finance Ministry will join the fight with targeted tax hikes on capital inflows.
"We have many options to raise the IOF financial tax and reap good results," said the second source, using the acronym for a levy on financial transactions. Both government sources sought anonymity because neither was authorized to speak on the record.
Regardless of government intervention, yield-hungry investors are expected to step up purchases of Brazilian assets in the coming weeks, driving up the value of the real, as central banks in the United States and Europe pump more money into financial markets -- a policy that Brazil's President Dilma Rousseff has denounced as a "monetary tsunami."
"I don't think the government is easily going to give up, but I do believe they're fighting a lost battle," said Kathryn Rooney Vera, a strategist at BullTick Capital Markets in Miami.
"Given the indefinite and aggressive nature of QE3, there will be sustained interest for Brazilian assets, really pushing investors to search for yield," she added, referring to the third round of quantitative easing measures unveiled by the U.S. Federal Reserve on September 13.
The Fed pledged to buy $40 billion of mortgage debt per month until the U.S. job market improves, a key difference from its first two rounds of monetary stimulus, both of which had a specified end date from the outset.
Dollar inflows have already started to pick up as a result. A net $1.03 billion flew into the country during the week of September 10-14, more than offsetting outflows of $575 million recorded in the previous period, central bank data showed.
To be sure, economic and monetary conditions have also changed during the past couple of years, potentially mitigating inflows to Brazil.
An economic slowdown in China, Brazil's main trading partner, will likely curb commodity prices and weigh on Brazilian exports.
And Brazil itself is not as appealing to foreign capital as it used to be. With interest rates at an all-time low and the economy expected to grow less than 2 percent this year, investors are less enthusiastic about the country than they were a couple of years ago, when the economy expanded at a rate of 7.5 percent.
"We're not a star anymore. The government has made that happen with a series of interventions and rules that increased risks for investors," said Sidnei Nehme, executive director at NGO brokerage in São Paulo.
THE INFLATION DILEMMA
Still, the stars seem to be aligning for a stronger real as the Brazilian economy regains momentum, probably reaching an annualized growth rate of 4 percent by the end of the year, and global monetary conditions become even looser.
A pick-up in domestic inflation could also make the central bank more tolerant to a stronger currency, which makes imports cheaper. Twelve-month consumer inflation in Brazil is currently running at around 5.2 percent, well above the 4.5 percent center of the government's target range.
Many analysts believe that to give the economy a boost, the central bank could allow inflation to accelerate toward 6 percent -- still below the target ceiling of 6.5 percent.
At that point, however, markets would begin to question the central bank's commitment to inflation targets, forcing policymakers to choose between higher interest rates or a stronger currency.
"Inflation is the Achilles' heel of the Brazilian story," Bank of America Merrill Lynch's analysts Claudio Irigoyen and Marcos Buscaglia wrote in a research note.
"Many clients think that if inflation keeps rising, the government will have to let the currency appreciate at some point in order to keep delaying the hike in rates," they added.
Since early July, the central bank has managed to keep the real within the 2.0- to 2.1-per-dollar range, or about 16 percent weaker from late February, intervening whenever the currency neared the edges of that range.
Between September 12-17, it sold about $5.7 billion in reverse currency swaps -- derivative contracts that emulate the purchase of dollars in the futures market -- to offset the appreciation trend stoked by the U.S. monetary stimulus.
The central bank could offer another $5 billion in currency swaps before letting the real strengthen past the level of 2 per dollar, said Sidney Yoshihiro, a strategist at Citibank.
"I am still holding my view that in a fight between the central bank and the world, pick the world. The central bank will defend the 2.00 line, and thereafter the 1.97/1.98 level, and so on," he wrote in a note to clients.
(Additional reporting by Brian Winter and Alonso Soto in Brasilia, and Natalia Cacioli in Sao Paulo; Editing by Todd Benson and Leslie Gevirtz)
- Tweet this
- Share this
- Digg this
- Scots vote on independence, United Kingdom's fate on knife-edge
- Islamic State releases video it says shows British journalist John Cantlie
- China not warlike, says Xi, as border standoff dominates India trip
- International country music singer George Hamilton IV dies at 77
- Jailed Fatah leader lauds Gaza 'victory', urges confrontation with Israel
China is not a warlike nation, President Xi Jinping said on Thursday, during a rare trip to neighbour India that was dominated by a standoff on a barren Himalayan plateau between soldiers from the world's two most populous nations. Full Article | Slideshow
Obama to nominate Indian-American Richard Verma as India ambassador - congressional source. Full Article