Analysis: Brazil financial market no longer expects a falling dollar rate: quite the contrary

RIO DE JANEIRO, BRAZIL – Although the calculations of most market participants indicate that the dollar is “too expensive”, the expectation about the fall of the American currency has decreased.

According to the latest Focus bulletin, the economists’ consensus for the dollar price at the end of the year changed for the first time in a month, from R$5.20 to R$5.25.

The adjustment in estimates comes amid a series of hikes that sent the U.S. currency to its highest level in six months this week. The appreciation of the dollar, which reached more than 5% in the last 30 days, was stopped only by the action of the Central Bank, which sold US$1 billion through market instruments last Wednesday (13).

Today, the dollar is trading at R$5.50, which is closer to its high for the year of R$5.75 than to its low of R$4.90, exceeding economists’ forecasts.

One of the financial institutions that recently changed its estimates for the currency is Necton. The brokerage firm, which ranks first in Focus’ short-term exchange rate rankings, raised its forecast for the dollar from R$5.30 to R$5.40 by the end of the year.

BNP Paribas, which ranks first in Focus’ long-term 2019 foreign exchange rankings, also changed its forecasts. At the beginning of the year, the French bank saw great chances that the American currency would fall below R$5 in 2021. Today, the prospect is that the dollar will remain stronger in Brazil and globally.

1 – FED EFFECT

Since then, what has changed is the perception of monetary tightening by the Federal Reserve (Fed), which will occur sooner than expected due to more stubborn inflation than anticipated.

According to the last Fed meeting minutes, released on Wednesday, November 13, the reduction in the money supply will occur later this year. That is, the $120 billion per month that the Fed pumps into the bond market will be reduced to zero. The process of withdrawing stimulus is expected to begin next month and end in the middle of next year.

For BNP Paribas economist Luca Maia, this was the main trigger for the global appreciation of the dollar. And this momentum is likely to continue for some time, in his opinion. “In the past, virtually all emerging assets [such as the stock market and currencies] have typically depreciated sharply during periods of tapering. It’s a smaller supply of dollars,” he says.

But even before the Fed withdraws stimulus and raises interest rates, the market has anticipated the move, pushing up yields on U.S. bonds (Treasuries), considered the safest in the world. At the beginning of the week, 10-year bonds reached their highest level since May, with a yield of 1.6%. But there are already bonds, such as the 2-year and 5-year, whose payments were only before the pandemic.

The move has boosted the dollar globally. The Dxy index, which measures the change in the U.S. currency against a basket of developed country currencies such as the euro, pound, and yen, has reached its highest level in 14 months.

“The higher the expectation that government bonds will rise, the stronger the dollar should become. The United States is becoming a fixed-income investment horizon again,” commented Jefferson Laatus, founding partner and chief strategist at Laatus Group to Exame newspaper. “Tapering has already occurred, the concern now is whether the Fed will raise interest rates sooner.

2 – BRAZILIAN CENTRAL BANK

Although it has gained value in the rest of the world, the dollar has risen even more in Brazil. While the real has lost more than 5% in the last 30 days, the Mexican peso and South African rand have lost less than 3.5%. Part of this difference, Maia believes, is due to less aggressive central bank action.

With inflationary pressures high and fears about the impact of the water crisis, the market expected a 150 basis point (bp) hike at the last Copom meeting.

However, this expectation was disappointed after the Central Bank’s president, Roberto Campos Neto, admitted that he would “maintain the flight plan a week before the decision.” In other words, it would raise only 100 basis points and be in the same range as the previous adjustment, as it had already announced.

Since then, the dollar, which was at R$5.20, has risen by 30 centavos. The change in strategy by the Central Bank, which raised rates more than expected at the beginning of the rate hike cycle, disappointed part of the market

“We believed that the normalization of interest rates would be faster. We see the Real positively, but with less conviction given the change in the central bank,” Maia says. “However, I believe that it still has time to change this attitude,” he adds. Maia says that signs of a possible change showed up this week with the central bank’s multibillion-dollar sale.

3 – COMMODITIES

Although the prices of commodities continue at high levels, the increase was not as expected by investors, who were already anticipating a possible “supercycle”. Maia recalls that the dollar reached its low in Brazil just when the price of iron ore was near its high of US$ 200 per ton.

“Two weeks ago, the ore price was below US$95 and has stabilized at US$130. Still, there has been a big change in industrial commodity prices,” the economist says. In his opinion, this variable is likely to be one of the main factors determining the dollar exchange rate in the coming months.

Although prices are above historical levels, the outlook for iron ore has changed with the deterioration of the assessment of the Chinese economy, especially the demand for steel from the construction industry, and the crisis triggered by Evergrande.

4 – FISCAL DETERIORATION

Taxes continue to be an issue at the country’s negotiating tables. For Jefferson Laatus, the decline in popularity of President Jair Bolsonaro could be a trigger for the deterioration of government accounts.

“There are two ways to gain popularity: creating jobs so that the population has an income or creating direct income through social programs. But the government does not have the resources to finance the increase in the Bolsa Família that would provide popularity,” comments Laatus. “This fiscal risk is causing investors to leave the country and the dollar to rise.

5 – PRESIDENTIAL ELECTION 2022

If the forecasts for the dollar are not optimistic this year, the expected scenario for 2022 is not the best. With the upcoming elections, investors fear the negative impact of polarization between President Bolsonaro and former President Luiz Inácio Lula da Silva.

“This shakes up a lot. The election is expected to be close. So there will be a lot of volatility and a high dollar exchange rate, especially if Lula is ahead in the polls next year. A third way would be the best option,” Laatus comments. “It is very difficult to have a dollar below R$5 this year, let alone next year,” he says.

“Historically, volatility is more significant in July to September of an election year. That should also have an impact on the exchange rate as the dollar rises. For BNP, the dollar should close below R$5 in 2022, but the decline is not expected until after the elections.