The Brazilian currency is in a state of vigilance

During the past week, we observed the Brazilian Real reaching the level of 5.05/USD, often surpassing the psychological threshold of 5.00 throughout the week; however, it closed last Friday within its comfort zone. It can be said that the Brazilian currency is in a state of vigilance, characterized by "the continuous and systematic collection, analysis, and interpretation of specific data to guide the planning, implementation, and evaluation of its value in the market."

The Monetary Policy Committee (Copom) unanimously voted to reduce the Selic rate by 50 basis points to 10.75% last Wednesday. This amounted to an accumulated easing of 300 basis points since the initial rate cut in August. The Copom continues to state that the duration of the cutting cycle depends on the data. With tighter guidance, some market participants may question if the end of the cycle is near. Traders are now pricing in an additional 28 basis point cut in June and a terminal Selic rate at the end of the cycle around 9.75%. In this sense, the market should continue to monitor inflation and labor market data to assess the Real - a prime example of vigilance.

A vigilance system also includes the ability to analyze the actions of the president. The government of President Luiz Inácio Lula da Silva has been accused of political interference in some of the country's largest companies, causing alarm among investors who fear a repeat of authoritarian interventions from the last left-leaning government period. Major companies like Petrobras and Vale have been affected by this political interference. At the same time, Brasília has attempted to reverse an element of the privatization of the energy company Eletrobras by former President Jair Bolsonaro. The controversies have raised the specter of state activism that often failed or proved costly when Lula's party was in power earlier this century, which, after a period of economic growth, resulted in a deep recession for the largest economy in Latin America.

Given the past experiences of undue political pressure that did not end well, we see these incidents having an impact beyond the mentioned companies, ultimately making it difficult for Brazil to attract investments. Undoubtedly, the government's momentum is terrible for the currency.

To counterbalance the storyline (but not so much), the first fiscal report of 2024 released on Friday showed that the government is on track to end the year with a primary deficit of 9.3 billion reais ($1.9 billion), or 0.1% of gross domestic product - below the maximum deficit of 0.25% in spending rules. The more positive outlook is partly the result of the success of Finance Minister Fernando Haddad in increasing revenue early in the year. However, financial markets remain skeptical that Haddad will achieve the budget target, with economists surveyed by the central bank projecting deficits of 0.75% of GDP this year and 0.6% for 2025. In this reasoning, investors bet that Lula will spend more in response to the economic slowdown and declining electoral support.

In my last commentary, I mentioned that volatility continues to decrease, as the currency has been trading between 4.80 and 5.00 over the past 12 months, and should continue to do so due to the state of vigilance. The currency breaking out of this range reflects more political noise than the interest rate narrative and fiscal outlook. Therefore, it is expected that the currency will return to trading within this range, at least until we have more evidence from the geopolitical space.

Abroad, the mood in the currency market remains changeable as always, keeping currencies operating within defined ranges but supporting the Dollar for now. The Fed unanimously voted to keep the federal funds rate target range unchanged at 5.25-5.50% at its January meeting. Going forward, inflation will be the key variable in determining the timing of interest rate cuts, and Fed Chair Jerome Powell indicated that a rate cut in March seems unlikely. Given the surprising rise in January inflation data and a strong labor market - thus I continue to predict the first interest rate cut in June.

However, ongoing geopolitical changes and numerous upcoming elections amid an already complicated global economic landscape mean more policy dilemmas, even with the slowdown in inflation. Election outcomes will inevitably impact the fiscal outlook but may also have implications for trade protectionism, environmental policies, and potentially immigration policies, in addition to geopolitics. The latter has become even more complex in the past three months, whether in US-China relations, conflicts in the Middle East, or uncertainty about future US and EU funding for Ukraine.

We are in an era of global disorder. Finally, to add a bit of mysticism to this conversation, according to the most recent data released by the Commodity Futures Trading Commission (CFTC), speculative net positions for the Real increased to 10.3 thousand. This increase suggests a positive outlook for the currency, with speculators potentially anticipating further strengthening of the currency in the short term. We would be fortunate if the state of vigilance were to last forever.