Dollar could be cheaper, but “Lula factor” plays against

A study released at the beginning of the month by XP Investimentos points out that, considering structural and cyclical factors, the Brazilian exchange rate could be between R$ 4.50 and R$ 4.85. In other words, the economic fundamentals would allow the real to appreciate against the dollar, currently quoted above R$5.20. The question is whether the federal government’s economic policy will allow this movement. For the time being, the “Lula factor” has not allowed the dollar to become cheaper.

A recent example illustrates how the speeches and initiatives of President Luiz Inácio Lula da Silva (PT) weigh on quotations. On the 2nd, driven by internal and external factors, the exchange rate fell below R$5 for the first time in eight months. During the day, it was traded for BRL 4.94, ending the session with an average quotation (Ptax) of BRL 4.99, according to the Central Bank.

However, on the night of the 2nd, RedeTV aired an interview with Lula in which, among other things, the PT member once again attacked the Central Bank’s monetary policy, calling the president of the monetary authority, Roberto Campos Neto, “that citizen” and promising to reassess the BC’s autonomy. Result: the following day, the average dollar rate jumped to R$5.10. The situation has worsened over the last week, with the dollar reaching R$ 5.25 in the average of transactions on Friday (10).

Economist Samuel Pessôa, a researcher at the Getulio Vargas Foundation (FGV) and partner at the Julius Baer Family Office (JBFO), also argues that the exchange rate could be much cheaper – something close to R$ 4.80, according to him. In an article in “Folha de S. Paulo”, Pessôa points out that Lula’s speeches and the fiscal worsening with the constitutional amendment that increased the spending ceiling – originating from the PEC fura-teto – have a cost of R$ 0.25 per dollar in exchange rate.

Brazil has “currency misalignment”, says XP

Economist Rodolfo Margato, author of the XP survey, points out that there is an exchange rate misalignment in Brazil, citing the difference between the current exchange rate and that defined by economic fundamentals.

The problem is motivated by the deterioration of fiscal prospects and noise in the domestic environment, such as Lula’s repeated attacks on monetary policy, inflation targets and Central Bank autonomy.

These domestic noises offset the improvement of external factors, such as the global weakening of the dollar and the rise in commodity prices, due to the economic reopening of China.

A survey by the broker shows that in three months – between the beginning of November and February – the currencies of the main emerging countries appreciated against the US dollar. The exceptions are the Argentine peso, the Russian ruble and the Turkish lira. The real had a slight appreciation of 1.5% in the period.

Margato points out that there is room for the strengthening of the Brazilian currency throughout 2023. But there are a number of factors that can influence in that direction. “This largely depends on a lower perception of domestic risks, especially in the fiscal field. And the year should be marked by difficult discussions in terms of economic policy, with several comings and goings,” he says.

Economists’ projections, however, show that there is great skepticism about the possibility of the dollar going to lower levels. According to the latest Focus bulletin, released by BC on Monday (6), the median of expectations points to a dollar of R$ 5.25 at the end of this year and R$ 5.30 in December 2024.

Dollar loses strength since September, but movement can be reversed

Since the last quarter of last year, the US currency faces a gradual weakening. “The interest rate went up a lot over there”, says economist and partner at Valor Investimentos, Gabriel Meira.

The DXY indicator, which measures the strength of the dollar against six major currencies, has lost 9% of its value since the end of September, indicate data from the investment platform Investing.com.

The devaluation was motivated by the possibility that the end of the high interest rate cycle in the United States is closer than imagined. The market works with the possibility of the last increase happening in March. Inflation in the largest global economy has been below expectations for four months now.

Part of the dollar’s losses, however, were reversed in recent days. The US job market data for January came in much stronger than expected, with the creation of 517,000 non-farm jobs. The expectation was 189 thousand. The result was read as a sign that the US economy is still heated and may require higher interest rates to keep inflation under control.

Margato points out that the disclosure of this data in the United States created a series of doubts in the market. “Will interest rates go up after March? Will there be room for a drop to happen in 2023? These are questions that are being asked now by economic agents,” he says.

Another factor that may contribute to reversing this situation of devaluation of the dollar, according to the commercial treasury superintendent of Banco Daycoval, Marcelo Sanches, is the positioning of regional leaders of the Fed (Federal Reserve, the American BC).

They highlighted that, given the worsening external scenario, it is plausible to consider an interest rate above 6% per year in the United States. Currently, it is in the range between 4.50% and 4.75%.

The market is also eyeing a possible mild recession in major global economies such as the United States and the Eurozone.

Inflation is showing signs of a break in the economies linked to the Organization for Economic Cooperation and Development (OECD). Prices ended 2022 up 9.4%, down from a 12-month peak of 10.8% in October and also the lowest level since April. In the euro area, forecast annualized inflation is 8.5% in January, according to EuroStat.

These are still very high rates, however. Lucas Serra, analyst at Toro Investimentos, there is a lot of work ahead in Europe. “They belatedly started raising the interest rate,” he says.

Another external factor also helps to explain the loss of value of the dollar in recent months, points out economist Cristiane Quartaroli, from the Ourinvest bank. It is about strengthening the Chinese economy, which favors emerging economies, which are very dependent on the Asian giant in terms of trade. Projections from the International Monetary Fund (IMF) point to a growth of 5.2% in Chinese GDP this year, against the 3% registered in 2022, according to the National Bureau of Statistics of China.

Geopolitical tensions would also be behind the weakening of the American currency, points out Meira. Among them are the war in Ukraine, tensions between China and Taiwan and energy problems in Europe.

Domestic tensions prevent stronger appreciation of the real against the dollar

Margato points out that, despite the more favorable external scenario, the Brazilian exchange rate has shown a lot of volatility and underperformed that of emerging peers in recent weeks. The biggest gain in the past three months was the Hungarian forint, followed by the Thai bath and the South Korean won.

The issue is that there is a lot of noise in Brasilia, say analysts interviewed by People’s Gazette. “The deterioration of fiscal prospects and political issues in the domestic environment offset the improvement in external factors”, explains the economist at XP.

“There is room for the real to strengthen throughout 2023. However, this largely depends on a lower perception of domestic risks, especially in the fiscal field. And the year should be marked by difficult discussions in terms of economic policy, with several comings and goings”, highlights Margato.

Inflation targets can affect the direction of economic policy and the dollar

A worrying discussion concerns the conduct of monetary policy and the setting of inflation targets by the National Monetary Council (CMN). Lula has frequently criticized the Central Bank and questioned the maintenance of interest rates at 13.75% a year. “But there is a bias towards prolonged maintenance of interest rates”, highlights the Daycoval executive.

According to Bloomberg, the government’s economic team is considering an early review of inflation targets, to alleviate tensions between the Lula government and the Central Bank. The topic can be discussed at the first meeting of the CMN this year, scheduled for next Thursday (16). The collegiate is made up of the Ministers of Finance and Planning and the President of the Central Bank.

Sanches points out that making the target more flexible could give the impression of tolerance with higher inflation. The targets up to 2025 have already been set by the CMN. They are 3.25% in 2023 (which may fluctuate between 1.75% and 4.75%) and 3% in 2024 and 2025 (with a tolerance interval between 1.5% and 4.5%). The definition for 2026 should be taken in June.

The market already works with targets revision scenarios. “An adjustment of 0.25 percentage points would be the least of all evils. The losses registered in the last few days by the financial market would be returned quickly”, says Sanches.

A worse scenario would be if there was a one percentage point change in the targets. The main impact, according to him, would be a lower real interest rate, which would reduce Brazil’s attractiveness compared to other emerging economies. “The flow of capital would decrease”, he says.

Another impact would be the increase in funding interest for Brazilian investors. He points out that this could make infrastructure works more expensive. It would also make it more difficult for private companies to access credit, which could be reflected in more inflation, as costs would increase.

Another noise is the discussion about the independence of the Central Bank, constantly criticized by Lula. The BC autonomy law entered into force in 2021, with the support of the government of Jair Bolsonaro (PL), and is supported by political leaders such as the presidents of the Senate, Rodrigo Pacheco (PSD), and of the Chamber, Arthur Lira (PP ).

Quartaroli, from the Ourinvest bank, points out that, at the moment, Brazil does not present a good background in the political and institutional scenario: “In addition to the fiscal situation that worries, it is necessary that the political and institutional issue provide a good story. , the country risk will remain high.”

Before the pandemic, in 2019, Brazil’s country risk – measured by the 5-year Credit Default Swaps (CDS), a derivative that is a kind of insurance against defaults – was around 100 points. It is currently at 214 points, but peaked at 311 points in September, during the election campaign.

Tax issue is a relevant factor in the dollar exchange rate

The tax issue is a relevant factor, highlights Serra, from Toro Investimentos. The ceiling-breaking PEC released almost BRL 200 billion in additional spending, beyond the original limits of the spending ceiling, which injects more money into the economy and increases the public deficit.

A relevant role, according to Meira, from Valor Investimentos, will be given by discussions on tax reform. According to him, these conversations and the greater or lesser effectiveness of the proposals will show the negotiating power of the federal government.

The XP economist believes that the presentation of a credible fiscal framework and advances in tax reform can be catalysts for strengthening the real. On the other hand, high uncertainties about the conduct of economic policy, involving fiscal and monetary guidelines, may widen the difference between current and “equilibrium” exchange rates.

“Whatever comes will be relevant to give credibility to investors. Until now, everything is an unknown”, points out Sanches.

Another question mark is in relation to the quasi-fiscal policy, which involves, for example, the injection of more credit by public banks or the progress of programs such as Minha Casa, Minha Vida. “This generates more pressure on the fiscal side”, says the Toro analyst.

“Empirical evidence shows that the real may be detached from economic fundamentals for a long time”, warns Margato.