November 19, 2019 / 6:39 PM / 24 days ago

Brazil real dips toward record low, but FX intervention alarm barely rings

BRASILIA (Reuters) - Brazil’s real may be sliding toward an all-time low against the U.S. dollar, but the central bank appears in no rush to intervene to slow or even reverse the fall.

FILE PHOTO: Brazil's Central Bank President Roberto Campos Neto is seen during an earlier event in Sao Paulo, Brazil, August 8, 2019. REUTERS/Amanda Perobelli/File Photo

Despite the real’s historical weakness, the market is functioning smoothly: depreciation, so far, has been fairly orderly, volatility is low, liquidity has not dried up, and the real is not the only emerging market currency under pressure.

And on Tuesday, central bank chief, Roberto Campos Neto, said the exchange rate was not fueling inflation or inflation expectations, indicating policymakers were relatively relaxed and that intervention was not imminent.

“We’re still not in ‘intervention zone’, although this should be the next step,” said a senior FX and rates trader in Sao Paulo.

A hedge fund manager in Sao Paulo agreed: “Campos Neto’s testimony today tells me they are not close to intervening.”

The dollar rose as high as 4.22 reais BRBY on Tuesday, having posted its highest ever close the day before at 4.2162 reais. That was a cent higher than the previous record high close from last year and within sight of an all-time peak at around 4.25 reais from 2015.

The dollar is now above the 4.20 reais level where the central bank intervened in August by selling dollars for the first time in a decade. That had suggested Campos Neto and deputy governor for monetary policy Bruno Serra, both former traders, might be more willing than their predecessors to run down Brazil’s $380 billion stash of FX reserves.

The exchange rate is one of the most closely watched barometers of international investor confidence in Brazil. But in testimony to the Senate Economic Affairs Committee on Tuesday, Campos Neto said policymakers were more concerned with the impact on inflation.

So far, there has been none at all. Annual inflation is just 2.54%, well below the central bank’s target for this year of 4.25%, and private sector forecasts suggest it will easily undershoot next year’s target of 4.00%.

MAJOR UNDERPERFORMANCE

If inflation is not a problem, neither is market liquidity.

Analysts point out that as former traders, Campos Neto and Serra will be finely attuned to the market’s day to day functioning, and if liquidity was an issue as it was in August, intervention would be a more immediate risk.

“The market appears to be functioning, so the dollar could rise further,” said Cleber Alessie Machado, FX broker at H. Commcor in Sao Paulo. “If the move is too fast and the dollar flirts with 4.25, the central bank could act. But it’s hard to say.”

Few analysts would have bet the dollar would be flirting with record lows in light of the government’s market-friendly reform agenda, including the approval last month of a landmark pension reform bill.

Yet the real is one of the worst-performing emerging currencies against the dollar this month and in the year to date.

Graphic: EM currencies vs dollar by month-to-date, here

Analysts say there are several reasons for this: political protests and upheaval across the continent, the domestic economic reform process slowing down, and an unexpected domestic political twist after ex-president, Luiz Inacio Lula da Silva, was let out of jail.

The main trigger for the latest bout of weakness, however, was Brazil's 'mega' oil auction earlier this month. Foreign bidders effectively failed to show up here meaning inflows into the country will be billions of dollars lighter than officials and traders had banked on.

Monetary policy is a factor too. Since Campos Neto was confirmed as president in February, the benchmark Selic interest rate has been slashed to a record low 5.00% and is set to be cut further. The real’s yield advantage, or ‘carry’ over other currencies, is evaporating.

Reporting by Jamie McGeever; Additional reprting by Karin Strohecker in London; Editing by Bernadette Baum

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