2021-03-29 12:33:45.173 GMT
By Adriana Dupita (Economist), Felipe Hernandez (Economist) and
Ziad Daoud (Economist)
(Bloomberg Economics) -- Domestic factors are the main
driver of Brazilís real this year. The erosion in market
sentiment largely outweighs the impact on the currency from
better-than-expected growth in early 2021 and the prospects of
higher interest rates.
* The Brazilian real has weakened nearly 10% this year through
March 26, making it the worst-performing emerging-market
currency in the period. The real has traded at levels misaligned
from the countryís external fundamentals for most of the past
year. The meltdown seen this year widens this gap.
* Several factors support the deterioration in sentiment, in our
view. We see them as mostly associated with fears of a flirt
with populism coupled with discomfort on pandemic management.
* If these factors are as relevant as the analysis suggests,
monetary policy alone wonít suffice to strengthen the currency.
Drivers of Brazilís Currency
What Has Driven the Real So Far?
* Our estimates suggest U.S. growth prospects have weighed
little on Brazilís currency. About 10% of Brazilian exports go
to the U.S., so stronger demand matters. Still, Brazilís
presence in global financial markets means it has significant
exposure to U.S. rates as well. The net effect of the U.S.
growth outlook has been close to zero this year.
* Activity indicators released in the first quarter showed
end-2020 and early 2021 growth surprising on the upside, and
news of another round of emergency cash handouts eased concerns
on near-term growth. This probably explains the modest
contribution of domestic growth to the currency oscillations.
* The BCB raised rates in March, but markets had been pricing in
a tighter monetary policy since mid-January. The effects of
monetary policy alone would have supported the currency,
according to our estimates.
* If all these factors were neutral or positive for the
currency, why has it depreciated so sharply this year? Our
exercise suggests sentiment is the key factor.
* The news flow in Brazil has been intensely negative this year
-- so much so that itís hard to pinpoint the main culprits.
Still, the timing of the currency oscillations suggests that
rising discomfort with policy mishaps is paramount.
* Our estimates captured significant, sentiment-driven moves in
the currency when President Bolsonaro fired the CEO of Petrobras
-- seen as an interventionist tilt; when a court ruling paved
the way for former President Lula to run for office again; when
markets perceived that a key legislation -- the Fiscal Emergency
law -- was under threat of excessive dilution; and when Congress
approved an unrealistic budget for 2021. At the same time, poor
management of the Covid-19 crisis is contributing. The overall
trend of worsening sentiment correlates with the surge in weekly
confirmed Covid-19 deaths.
* Our exercise shows that currency weakness this year has not
been driven by low interest rates or a less-friendly external
environment. More likely, itís the governmentís vague commitment
to a pro-market agenda and massive failure in containing the
* These results suggest that higher rates can help, but cannot
do much alone. The same applies to FX intervention. Selling
dollars does by itself not improve sentiment; and if it is
perceived to be an unsustainable policy, the effort to tame the
currency by intervening in the market may actually backfire.
How We Quantify Shocks
We assume the currency can depreciate (appreciate) for four
reasons: weak (strong) domestic growth, loose (tight) monetary
policy, deteriorating (improving) sentiment and faster (slower)
global growth, which can make foreign assets more (less)
attractive. These factors have different impacts on the co-
movement among the currency, equities and bond yields, allowing
us to quantify their effects on the real.
* Domestic growth: If the currency depreciates, equity prices
fall and bond yields decline, then itís a sign of a weaker
return to investments in Brazil -- a result of a negative growth
* Monetary policy: If the currency depreciates, equity prices
rise and bond yields decline, then itís an indication of looser
* Sentiment: When the real and equities fall, but yields rise,
we attribute the move in the currency to sentiment as investors
dump Brazilian assets.
* U.S. growth: When the real falls, but equities and yields
rise, the driver is likely to be faster U.S. growth.
The impact of the four shocks on asset prices is summarized
in the table below.
Impact of Different Shocks on Asset Prices
In terms of practical implementation, we split the day into
30-minute intervals during hours in which currencies, stocks and
bonds are all traded. We assume that only one shock affects the
currency in each of these intervals, which we identify depending
on the co-movement of asset prices as outlined above.
For example, if between 9:30 a.m. and 10 a.m. we observed
that the real depreciated, and that both equities and bond
yields declined, we would attribute the currency movement to the
domestic growth shock. If the real fell, yields declined and
stocks rose, we would attribute the move to the monetary policy
shock. Outside normal trading hours, we make the assumption that
only one shock impacts the real between the close of financial
markets and the start of the next trading day.
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