Forex Investment and Currency Trading

FX outlook: Recognizing that the strength of BRL in the face of current account balance deterioration was sustained by capital flows, the reduction in the pace of accumulation of FX reserves by the Brazilian central bank (BCB) was an indication of an impending change in the overall balance of payments situation and direction in USD/BRL. FDI remains strong, but contrary to common perception, it has not been the major source of inflows in the last couple of years. Foreign flows have been dominated by equity and debt flows. In this context, the significant reduction in portfolio inflows in the last couple of months and the prospect of further de-leveraging and overhang of global recession in particular for commodity-exporting credits/markets, suggests more FX weakness ahead.

Corporate exposure to FX derivatives, heavy corporate debt amortization schedules and risk of a harder landing have triggered the start of a revision towards lower earning estimates. This is a concern in the face of a 37% foreign participation, or roughly USD42bn, in the local equity market.

FX Policy: Unlike regional peers, the central bank (BCB) has relied on a wide variety of tools including FX repos, FX swaps, FX reverse swaps and the outright sales of dollars. This array of intervention tools has provided the BCB with flexibility and more importantly, allowed for preservation of FX reserves. The use of swaps and reverse swaps which settle in local currency amount to roughly 87% of the total intervention to date compared to 13% for outright sale of dollars in the spot market. Expect the
BCB to maintain this conservative mix of intervention going forward and sell spot only in the case of severe market moves. In effect, while total intervention has been large enough to prevent more significant depreciation of the BRL in the near-term, it is not sufficient to change the directional view on USD/BRL as this will remain driven by the broader risk of further adjustment in capital & financial
account flows and less favourable growth outlook.

Interest rates: The latest policy minutes by the BCB reinforces the view that Inflation risks are concentrated in the short-term, with the focus on current inflation, feed-through of wholesale inflation onto retail inflation, wage pressures, and pass-through, all in the context of a still heated domestic demand environment. There is increasing uncertainty in relation to longer-term inflation
risks as a result of the external scenario and how that plays out through domestic growth. There is an explicit concern over the risks for growth which is reflected in the government’s continuous appeal for banks to continue lending. This reinforces the view that the next move is a cut.