Brazil’s currency is weakening so quickly the central bank may soon be forced to set aside its free-market principles and sell dollar reserves to halt the slide.
Market volatility is rising, by some measures back to where it was when the central bank last sold foreign exchange reserves in November, and some analysts say the real’s near-daily drops to new lows are now undermining confidence in the currency.
Policymakers can reasonably say the real’s 14% decline this year is a natural function of falling interest rates, that all emerging currencies are under heavy pressure and the selloff is not fueling inflation expectations in Brazil.
Not that the central bank is sitting idly by. In recent weeks it sold some $6.5 billion in the currency swaps market, where hedging demand from asset managers and investors is strongest.
But these actions have failed to slow the real’s plunge, far less reverse it. The real weakened past 4.66 per dollar on Thursday, bringing its depreciation this week to 4%, one of its biggest weekly falls in years.
The previously unthinkable level of 5.00 per dollar is now on the horizon.
“I think they need to come with a program, perhaps announce a budget like $20 to $30 billion, either swaps or dollar reserves,” said Carlos Kawall, director at Asa Bank in Sao Paulo. “They should announce that they are ready to do both.”
Alexandre Song, portfolio manager at Macro Capital in Sao Paulo, warned that the longer the central bank lets the depreciation continue, the more traders will test its resolve and force it into an even greater policy response.
“It is clear that the small interventions in the swaps market are not working, and the real’s weakness is now becoming a self-fulfilling prophecy,” Song said. “It’s probably now time that the central bank has to start thinking of proper intervention.”
A central bank spokesman told Reuters any intervention, whether in the derivatives or spot market, is determined by “market conditions.”
Central bank chief Roberto Campos Neto has said repeatedly this year that the real is a free-floating currency, implying a reluctance to forcefully determine its path or level.
He and Bruno Serra, deputy governor for monetary policy and head of the bank’s foreign reserves policy, are from trading backgrounds and firm believers in letting free markets determine asset prices. University of Chicago-educated Economy Minister Paulo Guedes is renowned for his laissez-faire economic views.
With Brazilian interest rates at a record low 4.25% — and likely to go even lower as the economic outlook dims — a weak exchange rate is simply “the new normal,” according to Guedes.
Treasury Secretary Mansueto Almeida on Thursday said exchange rate policy is the sole responsibility of the central bank, adding that the Treasury and the monetary authority never take coordinated action on the real.
As reluctant as Campos Neto and his colleagues might be to tap the central bank’s $360 billion stockpile of FX reserves, the market might force their hand.
Implied three-month volatility on the dollar/real exchange rate rose to 12.5% on Thursday. That is higher than November, when the central bank last sold dollar reserves, and is closing in on the 14% in August, when the central bank unleashed its first dollar-selling intervention in over a decade.
Tony Volpon, chief Brazil economist at UBS in Sao Paulo and former central bank director, said FX intervention is a limited resource that policymakers will only resort to when they feel they must.
“But the central bank doesn’t want to lose control of the currency. It has to keep an eye on financial stability,” Volpon said. “They need to maintain an orderly FX market.”