Brazil: Markets test central bank as currency touches new low

By Sober Look

Brazil’s financial markets remain under pressure. In spite of some recent interventions, including a rate hike, the currency touched another multi-year low today. The market is “testing” the central bank with bets that the real has more downside (many economists think it is still overvalued). The currency has also come under pressure due to a wide open presidential race (see story), adding to the overall economic uncertainty.

USD/BRL (source: Investing.com)

WSJ: – The Brazilian real fell to its weakest level against the dollar since April 2009 on Wednesday, as the lack of central bank intervention encouraged investors to drive it lower.

The dollar advanced against the real to buy as much as BRL2.3205, a level not seen in more than four years.

Brazil’s currency has consistently struggled in recent weeks as the country’s sluggish growth and persistently high inflation has made investors wary. Recently, market participants have been testing Brazil’s central bank by selling the real and driving it to fresh lows, analysts say.

The central bank has intervened in markets in recent weeks by holding dollar swap auctions to try to slow the depreciation of the real. Investors had expected the central bank to defend BRL2.30 per dollar, but have found that over the past couple of sessions to be unresponsive to the real’s weaknesses.

Government bond yields jumped, with the 5-year trading above 11.5% again. While the government is trying to highlight the positive trends in Brazil’s economy (see story), the debt and currency markets are not buying it. Business confidence is now at the lowest level since the Great Recession and some expect it to go lower. The situation with consumer confidence and retail sales is not much better.

Source: Tradingeconomics.com

The economy is facing other headwinds as well.

1. The combination of higher rates and risks of corporate debt downgrades (see story), will significantly increase the cost of borrowing for Brazilian firms.

2. Recent Brazilian IPO deals have had some “difficulties” (see story).

3. The government is pressuring banks to pump out loans in order to help boost growth. But that could backfire on the banking sector if economic conditions deteriorate further (see story).

And now, in the face of these economic challenges, the central bank may be forced to raise rates again to stop the real’s fall. While inflation has stabilized recently, the nation’s inability to stem currency declines could send prices higher again.