Analysis: Dollar down 6% since early March, back to R$5.40; will the slump continue?

RIO DE JANEIRO, BRAZIL – Analysts in Brazil assess that the U.S. currency may continue to drop, but it depends on the U.S. Federal Reserve and on Brazilian domestic politics.

Yesterday, the U.S. dollar registered only its second high in the last 10 trading sessions, although still down 5.8% since its peak on March 8th, from R$5.80 to R$5.46. The currency is at similar levels to those recorded in February, when it reached R$5.42 and is close to the median projections of financial market economists for the exchange rate at the end of the year, of R$5.40, according to the Central Bank’s Focus Report.

For analysts, the drop in the last 4 weeks is natural, but it is too early to say that the long-term trend of the U.S. currency against the Real will not be upward. To this end, the message from the Federal Open Market Committee (FOMC) on Wednesday, April 28th, and the progress of the political agenda in the Brazilian Congress need to be analyzed.

According to Faria Jr., director of Wagner Investimentos, there are two factors behind this drop: one is the external scenario of dollar depreciation against currencies of emerging countries and the other is the settlement of some of the political problems in Brazil that worried foreign investors.

In relation to the global trend of the dollar, Faria Jr. recalls that drops in the dollar index are still expected as the market waits for the direction of monetary policy and the Federal Reserve’s balance report.

“The U.S. supply chains are not fully recovered from Covid-19, there are still delays in supply deliveries, which generates price pass-throughs to the CPI [Consumer Price Index],” comments the specialist. “It is important to know whether the Fed considers that this rise in commodity prices and the pass-through to final prices is a temporary issue or not.”

For him, if the signals from the U.S. central bank follow the path of maintaining the current levels of asset purchases to inject money into the economy and interest rates near zero, then the dollar should continue to drop. On the other hand, if a change in the purchase of bonds is announced, an appreciation of the American currency is expected.

In relation to the local scenario, Faria Jr. considers that investors are relieved with the Budget sanction, after vetoes for parliamentary earmarks, built in common agreement between the Ministry of Economy and Congress. “The unfeasible Budget as it was was a great source of turbulence in the markets.”

In his assessment, the Real tends to improve its performance as long as Chamber of Deputies president Arthur Lira (PP-AL) continues to address the approval of the administrative and tax reforms once the Budget soap opera is over.

Lira said today on his Twitter account that the Chamber and Senate are committed to voting on the tax and administrative reforms later this year – the latter being able to move more quickly and have its special committee installed between May 10th and 14th.

“I am not overoptimistic, but I am optimistic,” said Marcos Weigt, Travelex’s treasury chief. “We have realized over time that Congress is reformist. The agenda has changed, we are now in a more propositional agenda,” he added, evaluating that the Covid-19 Parliamentary Inquiry Committee (CPI) in the Senate does not tend to move the markets.

The discussion about reforms had been put aside lately amid the worsening of the health crisis and debates about more expenses to control the pandemic, which led in early March to the approval of an Emergency PEC (constitutional amendment) that caused noise in the market later aggravated by the Budget impasse.

For Faria Jr., this improvement in the domestic news is coupled with the mismatch with which the Real was operating against the other currencies of developing countries, since the currencies of emerging countries such as South Africa and Chile, for example, hit their highest post-pandemic levels in recent weeks.

“This meltdown of more than 30 centavos is natural. Today, the dollar operating in this band between R$5.42 and R$5.48, leaves us very close to the supports of R$5.48 and R$5.44. The first is the medium-term trend line and the second is the concentration of long-term investors. It is a cushion of support,” he explains.

Time to buy?

However, Faria Jr. doesn’t believe that the dollar will tend to drop in the long term in relation to the Real. “The data from the Brazilian economy for March and April will not be so good and we need to see how the Central Bank is perceiving this scenario of inflation and employment. For those of you who are dollar buyers, it makes sense to start buying now with the aim of price-mediating,” he recommends.

Weigt said he would not be surprised if the dollar reached R$5.30 or R$5.20. “If we really start this reform agenda, if we approve the administrative one, we will get to R$5.”

While not sustaining a directional bet in favor of the Brazilian currency, Morgan Stanley sees in the excess volatility of the exchange rate in the short term a tactical opportunity, against the backdrop of a benign environment in terms of risk in which the dollar may be reaching its floor in the world.

“Short-term volatility in the Real continues to trade at a premium versus its peers and longer maturities, which makes exposure to a steeper curve attractive as we expect the second half of 2021 to be more challenging as the political calendar complicates the scenario for structural reforms,” they said.

The volatility of the three-month dollar/real stood at around 17.5% per year, the second highest among major international currency pairs. The volatility of the Turkish lira is the highest: 20.7%.

Strategists at JPMorgan, in turn, see a period of stabilization in the exchange and interest rates in Brazil compared to its emerging peers, after a poor performance in recent months.

In addition to the less chaotic political-fiscal news, the American bank draws attention to the effect of SELIC increases on the exchange rate – JPMorgan projects a new 75-basis point increase in the benchmark interest rate in May.

“We estimate that for every 100 basis points [1%] of interest rate increases in Brazil relative to emerging markets a total of US$2.3 billion in short positions in Real in FX contracts on the domestic exchange can be reversed, which represents significant support for the Brazilian currency.”

The strategists also evaluated that despite the recent improvement, the Real still does not seem “stretched”, which would leave room for further appreciation.

For Bernardo Zerbini, one of the heads of macro strategy at AZ Quest, the exchange rate is entering a “benign window” that, if extended, could end with the dollar between R$5.35 and R$5.40.

“We are increasing cautiously optimistic positions mainly in the stock market and foreign exchange,” he said. “We had a slightly smaller position in the Real, now we have increased it. We were overpricing (the exchange rate), considering metrics like terms of trade and others.”

Several financial institutions have pointed out that the Real was or is among the cheapest currencies in the emerging world, after depreciating more than 20% last year and dropping another 5% in 2021.

Rio Bravo also sees room for more downward correction in the dollar, but has doubts about the sustainability of the movement.

“The political and fiscal problems will continue, because it is kind of the Brazilian reality… And there in the United States the discussion of inflation, of increasing the yield curve, of interest rate futures, has cooled down a lot, but it is something that can return to the radar, especially with these new stimulus discussions on different fronts in the U.S.,” said Evandro Buccini, director of fixed income and multimarket at Rio Bravo.

A favorable scenario for the Real, according to the manager, is the continuation of the SELIC normalization cycle, but under certain circumstances.

“We have to see how inflation is going to behave in this situation. If the Central Bank needs to raise interest rates more because of an inflation that comes with the economic recovery, I think it is good for the exchange rate. In addition to higher interest rates, we would have growth.”

Source: Infomoney