BRASILIA (Reuters) – The Brazilian real, one of the world’s worst performing currencies this year, will benefit from a stronger-than-expected central bank rate hike on Wednesday and the promise of a second dose in May. .
The central bank’s aggressive start to its tightening cycle, following the recent boom in foreign exchange market intervention, will put a floor below the real in the near term, analysts said.
Signals from the US Federal Open Market Committee on Wednesday that no rush to raise US interest rates should also keep the dollar under control, providing another layer of support for emerging market currencies.
Strategists at the global FX powerhouse of Citi and Barclays are among those who recommend buying real, via the derivatives market, in the belief that it will strengthen against the dollar over the coming weeks, and maybe even months.
However, the medium-term outlook may be less certain.
Even though Brazil’s central bank raised its official borrowing costs by 75 basis points to 2.75% and said it is likely to do so again in May, real interest rates will still be negative for some time, and therefore relatively unattractive to investors.
Inflation was running at 5.2% and headed for more than 7% in the middle of the year before easing. The central bank’s own forecast on Wednesday has ended the year at 5.0%, well above its official target of 3.75%.
Graph: Brazil real exchange rate –
Moreover, the consensus among economists holds that while the central bank’s rate-setting committee, known as Copom, has started its cycle of aggressive tightening, the end point for interest rates may not change much, if at all.
This is happening against the backdrop of a worrisome public health crisis. Brazil is now the global epicenter of the COVID-19 pandemic, and a deadly second wave and slow vaccination program poses a danger to the economy and public finances.
“Real will likely benefit from the results of March’s FOMC and Copom meetings, but are not out of the woods yet. In the near future, the evolution of the pandemic and vaccine launches remains the real key, ”UBS strategists wrote in a note on Thursday.
Morgan Stanley strategists withdrew their recent calls to sell the real and now expect “some short-term stabilization in the currency” following Brazilian and US policy moves on Wednesday, but warned that “medium-term risks remain intact.”
ASK FASTER, NOT FURTHER
On the domestic interest rate front, one of the key issues for real long-term performance is the extent to which investors’ expectations of the Copom tightening cycle shift.
So far, the signs: not many.
Prior to Wednesday’s decision and statement, the consensus view of more than 100 economists in the central bank’s weekly “FOCUS” survey was that Selic will end this year at 4.50% and next year at 5.50%.
While some economists have since put forward their rate hike estimates, few have actually raised them. As such, the central bank is now expected to raise interest rates sooner, but in the end no further than originally estimated.
Currency moves on Thursday provide an early indication of how much tightening is already in real prices. It was sharply higher at the open, almost 2% at one point, but by the middle of the day it was up nearly 1% around 5.54 reais.
While many countries are vaccinating large portions of their population against COVID-19 and opening up their economies, Brazil has fully vaccinated less than 3% of its population and has recorded record numbers of new cases and deaths.
The national public health system is on the brink of collapse, several states will return to lockdown and the government on Wednesday said the economy was likely to shrink 0.35% in the first quarter. Many economists are projecting deeper declines and say risks in the second quarter have increased.
The primary measure of investors’ level of fear of Brazil’s public finances and of their ability – or willingness – to reduce their record debt is the interest rate curve. The steeper curve reflects the increased risk premium built into longer term debt maturities.
Some of Brazil’s exchange rate curves have climbed to record levels in recent weeks. The central bank’s bold action to counter rising inflation and rising fiscal risks will help flatten it, analysts say.
But as of Thursday morning, the gap between January 2022 and January 2027 futures prices is still nearing last week’s record high of around 440 basis points and is actually widening slightly.
Graph: Difference in Brazilian exchange rates –
Reporting by Jamie McGeever; Edited by Dan Grebler