American inflation and the future of the dollar and interest rates in Brazil – 07/12/2023 – Vinicius Torres Freire

Anyone who pays any attention to economic news must have noticed the sharp change in the dollar. The American currency was sold at R$ 5.40 on January 5th. It dropped to R$4.99 on February 2nd. It jumped to R$5.30 on March 15th and withered to R$4.91 on April 13th. The last high sigh was at the end of May, at R$5.10. This Wednesday, it closed close to R$ 4.81.

The bumps have not been exclusive to the real, although the Brazilian currency tends to be a leader in terms of exaggeration. Doubts about what would be done with the public debt and inflation contributed to financial instability. But it has become clearer that the comings and goings of inflation expectations and interest rates in the United States have had a decisive influence here, as expected.

And? The future of American inflation and, therefore, basic interest rates in the United States says something not only about part of the variation in the dollar, but also about basic interest rates in Brazil.

The difference between the US and Brazilian interest rates is important for the dollar price. Interest rates in similar countries also matter — they are alternative destinations for waves of capital.

Basic interest rates in the United States, moreover, indicate a kind of floor for Brazilian rates. Roughly speaking, our rate would be the American rate plus a risk premium (having reais, investing in Brazil, lending to the Brazilian government, etc.).

Expectations about what will become of interest rates in the United States have bounced a lot, depending on inflation numbers, the job market and the moods of the Fed, the American central bank.

This Wednesday was a day of animation, with the release of a low inflation number, which reached 3% per year – the Fed’s target is 2%. In the market-wide guess, the Fed would raise its base rate just one more time this year, to 5.5%, cutting in 2024.

The lower the interest rate over there, the more interest rates can fall over here (“everything more constant”: if other relevant factors do not change). The greater the difference in interest rates between Brazil and the US, the lower the pressure for the devaluation of the real.

If the perspective is that the Selic will fall slowly, given the level of economic activity that is still resistant, it is also expected, of course, that the difference in interest rates will fall more slowly.

The Selic will fall, as well as longer term rates. The difference in rates will decrease. A more behaved exchange rate, with the real less devalued, has contributed to lower inflation.

Apart from these general theories about exchange rate movements, any other speculation on the subject is reckless. In any case, a new wave of devaluation of the real would now be a problem.

The real had a big drop at the beginning of the epidemic, in February and March 2020, far beyond what was seen in other currencies, even those of similar countries, “peers”. Despite this year’s recovery, it is still relatively undervalued. For the record: in January 2020, considering inflation, it averaged BRL 4.63; on average from 2017 to 2019, close to R$ 4.

But this is just arithmetic, not economics. The future of government deficits and debt, the GDP growth rate or foreign investment in Brazil may be relevant factors. The summary of the opera is that it is not possible to think about what is going on in the economy here without looking at the world, as is our custom, and that there is risk beyond our control. Therefore, it is necessary to be even more prudent and rational here at home. The environment has improved, important changes have been approved, despite the rest of the political rhetoric. The “macro” issue will now be meeting fiscal targets.

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