Dollar Exceeds R$4.28 Hitting Historic High – Central Bank Intervention Unlikely

RIO DE JANEIRO, BRAZIL – The dollar once again topped its historic high, exceeding R$4.28 on Friday, January 31st, reflecting the market’s latest risk aversion factor: the coronavirus.

The disease’s potential impact on the global economy, which was classified as a global health emergency on Thursday by the World Health Organization (WHO), continues to frighten the market, which is looking for less risky assets and exiting the emerging ones.

This was one of the reasons for the drop in the Brazilian real by around six percent in January, the second worst performance among emerging nations, losing only to the South African rand. This performance increased speculation about whether the Central Bank would act more forcefully to contain the currency, following the late November 2019 example.

At the time, the Central Bank auctioned the dollar twice on November 26th, on the grounds that the real was dysfunctional and detached from other currencies. Interventions ensued and on November 28th there was a cash auction of US$1 billion, which helped boost the real by more than one percent in intraday trading.

However, for the moment the Central Bank is not expected to act forcefully in the foreign exchange market, according to an assessment by Morgan Stanley’s strategy team, pointing out to indications that the monetary authority is comfortable with the dollar at its current levels.

One of the reasons for non-intervention at the moment is the “proxies” of stress for the Brazilian market, which continue at low levels, since the country holds large reserves and the 10-year CDS (a kind of default insurance) is around 170 points, at low levels compared to its historical average.

The CDS works as one of the main risk indicators among the economies. The higher the CDS, the riskier the country is considered by investors.

Furthermore, inflation expectations continue to decline: for 2020, the projection for the IPCA (Broad Consumer Price Index) – according to the latest Focus survey – is 3.47 percent from a target of four percent for this year.

“Based on recent comments from members of the Central Bank, we believe that they are very comfortable with current dollar levels, particularly with the view that the pass-through (transmission of the exchange rate to prices) is not a worry and reserve stocks are at their ideal level,” they say.

This week, in an event promoted by Credit Suisse in São Paulo, Roberto Campos Neto, president of the Central Bank, stated that the monetary authority is constantly assessing whether the rise of the dollar influences other risk variables, either by delaying investment decisions or contaminating the inflation outlook – and neither of these cases occurred with the recent rise of the currency.

Campos Neto emphasized that the dollar’s rise is not related to the Brazil risk or other economy indicators – but rather as an effect of the interest curve, i.e., of market agents’ projections for the future behavior of interest rates.

He pointed out that the dollar’s pressure in recent months occurred due to the demand of Brazilian companies that used the low interest rates in Brazil to pre-pay debts in foreign currency.

In November, banks were struggling with the shortage of dollars in the market due to debt payments, which were being exchanged for local currency. Today, however, this trend is no longer as intense.

Morgan’s strategists further point out that, unlike in November, when the market had a significant sold position in Brazilian real, current indicators do not show this position, which would suggest a greater involvement of speculators in the behavior of the Brazilian currency.

In this respect, the US bank believes that the dollar is likely to test new highs, with the likelihood of intervention increasing only if the exchange rate volatility records levels similar to those in November 2019.

In this sense, with the Central Bank maintaining its “dovish” (soft) rhetoric and with the expectation that the Monetary Policy Committee (COPOM) will once again cut interest rates at next week’s meeting to 4.25 percent per annum, strategists do not believe that the real should show a recovery trend in the near future.

However, for Brendan McKenna, currency strategist at Wells Fargo & Co. in New York, the Central Bank will intervene at some point, but may wait a little longer before acting in the market, he stressed to Bloomberg.

Alejandro Cuadrado, strategist at Bilbao Bank, also pointed out to Bloomberg that the monetary authority will most likely not advocate a level for the dollar, precisely due to the current macroeconomic scenario. “They will not have a major intervention to reverse this, because it is a global adjustment,” he said.