Brazil’s central bank in firepower test with currency speculators

Brazil’s central bank in firepower test with currency speculators

Monetary policy looks at projections and expectations for inflation and will not be used to control the foreign exchange rate
Image result for ft Ilan Goldfajn, president of the Central Bank of Brazil,
Ilan Goldfajn, president of the Central Bank of Brazil.

Brazil’s central bank president Ilan Goldfajn is facing the test of his career as the country’s currency has once more come under assault from foreign exchange traders.

Mr Goldfajn, formerly an economist with Brazil’s largest private sector bank, Itaú Unibanco, has warned speculators he has the firepower to see them off in the form of dollar swaps, in effect a bet against the dollar settled in the local currency, the real.

During the last bout of volatility before he took over in 2016, the central bank issued $115bn of the instruments. This time, the central bank has sold only slightly more than one-third of this amount, leaving it with plenty of room for more, in addition to its $380bn in reserves.

“We can exceed the amount [of swaps] offered in the past,” Mr Goldfajn said in a speech to a Goldman Sachs conference on Monday. “We will intensify their use in the near term.”

After the central bank committed to offering a total of $24.5bn new swaps by the end of this week, the real strengthened from its weakest levels last week of more than R$3.90 against the dollar to about R$3.68 on Tuesday.

The country’s stock market, the Ibovespa, rallied early on Tuesday but has slumped more than 15 per cent in less than a month to 73,000, a level last seen in December. Brazil’s benchmark 10-year US dollar denominated bond yield rose above 6 per cent on Tuesday, up from 4.5 per cent earlier in the year, highlighting the scale of financial pressure facing the economy. Brazil’s local currency five-year government bond yields has risen towards 11 per cent from below 9 per cent in recent weeks.

For some investors, a buying opportunity has yet to materialise for Brazil.

“We are underweight or short pretty much everything in Brazil,” said Paul Greer, emerging market debt portfolio manager at Fidelity International in London. “We think the central bank’s move has been ill-advised, and they are doing it with no support from monetary or fiscal policy … This is not at all a buying opportunity.”

The Bank of America Merrill Lynch monthly survey released on Tuesday said investor “expectations are for the Ibovespa to remain between 65,000 to 85,000 while a third of participants expect the real above R$3.8 at year-end, a jump from mere 3 per cent in May”.

The factors that have driven the real down 10 per cent since January to become the second-worst performing in Latin America this year have not gone away, namely rising US Treasury yields and political uncertainty as Brazil in October faces its most unpredictable election in decades.

“The trend was driven by the external backdrop and the local political scenario,” said David Beker, economist with Bank of America Merrill Lynch.

The sudden swings in the real over the past month have battered a market that had taken a benign view of Brazil’s economic prospects.

Last month, a market rout in Argentina unnerved investors. The final straw for a re-rating of Brazil came when the normally pro-market government of President Michel Temer caved in to striking truckers and offered them a costly fuel subsidy.

With populists from the left and the right leading in early polls for the October elections, investors began selling on concern that Brazilian voters were not ready for tough fiscal reforms that economists believe will be necessary to restore sustainable growth in Latin America’s largest economy.

“The scenario is becoming increasingly challenging,” Itaú chief economist Mario Mesquita wrote in a research note. “Uncertainties surrounding the approval of reforms … remain high.”

The rapid falls in the currency last week before the central bank’s promise of mass intervention through the use of swaps prompted debate over whether Brazil would need to follow Argentina’s example and drastically increase interest rates via the Selic.

But with inflation at two-decade lows and the economy running at undercapacity, higher interest rates would not make sense, economists argued.

“The Selic should not be used as the front line of defence against currency movements,” said Zeina Latif, economist with XP Investimentos, a brokerage in São Paulo. She said Brazil’s sound external position with a low current account deficit and minimal foreign debt meant it should be able to manage currency volatility without resorting to interest rate rises.

But she added that given the “many uncertainties, it’s not possible to completely rule out a scenario of an increase in the Selic this year”.

For his part, Mr Goldfajn, a pro-market economist who studied under Stanley Fischer, former vice-chairman of the US Federal Reserve, has sought to emphasise that monetary policy will not be used to deal with currency volatility.

“Monetary policy looks at projections and expectations for inflation and… will not be used to control the foreign exchange rate,” he told the Goldman Sachs conference.

But he added that in the long run, the only way for Brazil to return to sustainable growth would be if it continued “on the path of adjustments and reforms”.

Financial Times.

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Image result for ft Ilan Goldfajn, president of the Central Bank of Brazil,
Ilan Goldfajn, president of the Central Bank of Brazil.

Brazil’s central bank president Ilan Goldfajn is facing the test of his career as the country’s currency has once more come under assault from foreign exchange traders.

Mr Goldfajn, formerly an economist with Brazil’s largest private sector bank, Itaú Unibanco, has warned speculators he has the firepower to see them off in the form of dollar swaps, in effect a bet against the dollar settled in the local currency, the real.

During the last bout of volatility before he took over in 2016, the central bank issued $115bn of the instruments. This time, the central bank has sold only slightly more than one-third of this amount, leaving it with plenty of room for more, in addition to its $380bn in reserves.

“We can exceed the amount [of swaps] offered in the past,” Mr Goldfajn said in a speech to a Goldman Sachs conference on Monday. “We will intensify their use in the near term.”

After the central bank committed to offering a total of $24.5bn new swaps by the end of this week, the real strengthened from its weakest levels last week of more than R$3.90 against the dollar to about R$3.68 on Tuesday.

The country’s stock market, the Ibovespa, rallied early on Tuesday but has slumped more than 15 per cent in less than a month to 73,000, a level last seen in December. Brazil’s benchmark 10-year US dollar denominated bond yield rose above 6 per cent on Tuesday, up from 4.5 per cent earlier in the year, highlighting the scale of financial pressure facing the economy. Brazil’s local currency five-year government bond yields has risen towards 11 per cent from below 9 per cent in recent weeks.

For some investors, a buying opportunity has yet to materialise for Brazil.

“We are underweight or short pretty much everything in Brazil,” said Paul Greer, emerging market debt portfolio manager at Fidelity International in London. “We think the central bank’s move has been ill-advised, and they are doing it with no support from monetary or fiscal policy … This is not at all a buying opportunity.”

The Bank of America Merrill Lynch monthly survey released on Tuesday said investor “expectations are for the Ibovespa to remain between 65,000 to 85,000 while a third of participants expect the real above R$3.8 at year-end, a jump from mere 3 per cent in May”.

The factors that have driven the real down 10 per cent since January to become the second-worst performing in Latin America this year have not gone away, namely rising US Treasury yields and political uncertainty as Brazil in October faces its most unpredictable election in decades.

“The trend was driven by the external backdrop and the local political scenario,” said David Beker, economist with Bank of America Merrill Lynch.

The sudden swings in the real over the past month have battered a market that had taken a benign view of Brazil’s economic prospects.

Last month, a market rout in Argentina unnerved investors. The final straw for a re-rating of Brazil came when the normally pro-market government of President Michel Temer caved in to striking truckers and offered them a costly fuel subsidy.

With populists from the left and the right leading in early polls for the October elections, investors began selling on concern that Brazilian voters were not ready for tough fiscal reforms that economists believe will be necessary to restore sustainable growth in Latin America’s largest economy.

“The scenario is becoming increasingly challenging,” Itaú chief economist Mario Mesquita wrote in a research note. “Uncertainties surrounding the approval of reforms … remain high.”

The rapid falls in the currency last week before the central bank’s promise of mass intervention through the use of swaps prompted debate over whether Brazil would need to follow Argentina’s example and drastically increase interest rates via the Selic.

But with inflation at two-decade lows and the economy running at undercapacity, higher interest rates would not make sense, economists argued.

“The Selic should not be used as the front line of defence against currency movements,” said Zeina Latif, economist with XP Investimentos, a brokerage in São Paulo. She said Brazil’s sound external position with a low current account deficit and minimal foreign debt meant it should be able to manage currency volatility without resorting to interest rate rises.

But she added that given the “many uncertainties, it’s not possible to completely rule out a scenario of an increase in the Selic this year”.

For his part, Mr Goldfajn, a pro-market economist who studied under Stanley Fischer, former vice-chairman of the US Federal Reserve, has sought to emphasise that monetary policy will not be used to deal with currency volatility.

“Monetary policy looks at projections and expectations for inflation and… will not be used to control the foreign exchange rate,” he told the Goldman Sachs conference.

But he added that in the long run, the only way for Brazil to return to sustainable growth would be if it continued “on the path of adjustments and reforms”.

Financial Times.

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