Real Rebound Seen as Brazil Addresses Inflation: Market Reversal

Monday, May 20, 20130 comments

Brazilian central bank President Alexandre Tombini’s commitment to fighting inflation is increasing the prospects the real will rebound from a four-month low, trading patterns show.
The currency weakened 0.7 percent against the dollar last week, sending it outside the so-called trading envelope for the first time since March, which typically indicates that a decline will be difficult to sustain. The real is deviating the most from its typical Bollinger band among the 31 most-traded currencies after the Turkish lira and Singapore dollar.
Tombini told reporters in Rio de Janeiro on May 16 that he will “do what’s needed” to lower inflation, which breached the 6.5 percent ceiling of policy makers’ target range in March. The currency is trading at a level that is 1 percent weaker than the rate that triggered the last central bank intervention, on March 27.
Brazil is a unique case in terms of the fact that you have a much more alarming inflation situation than almost any other emerging-market country,” Eamon Aghdasi, a strategist at Societe Generale SA in New York, said in an interview on May 17. “Policy makers are still concerned enough about inflation that they don’t want a sharp depreciation and what that might imply for domestic prices.”
A central bank official declined to comment on the possibility of currency intervention.
The real depreciated 0.4 percent to 2.0352 per dollar on May 17, the weakest close since Jan. 23. It dropped for a third week on concern the Federal Reserve will scale back stimulus measures, reducing investment in the largest developing economy after China.

Brazil Inflows

Brazil’s foreign currency inflows from trade and investment have amounted to $2.3 billion this year through May 10, compared with $22.6 billion in the first five months of 2012, central bank data show.
The central bank sold $995 million in currency swaps, which is equivalent to selling dollars in the futures market, on March 27, a day after the real slid to a two-month low of 2.0173 per dollar. On Jan. 28, it sold $1.8 billion in currency swaps to limit the real’s decline, triggering the biggest rally in seven months.
Policy makers have switched over the past few months between selling currency swaps to prevent the real from falling too much and offering reverse swaps to protect exporters by reining in gains. The measures have kept the real in a range of 1.95 and 2.05 per dollar this year.

SocGen Target

Aghdasi advised his clients to buy the real through non-deliverable forwards, targeting an advance to 1.978 per dollar.
Trading envelopes show the real’s decline over the past 20 days has strayed from its average by more than two standard deviations, which typically occurs about 2.5 percent of the time. When such a pattern last happened on March 27, the real gained 1 percent in following month. A similar breach in December also marked the trough of the currency.
The currency also crossed the upper end of its Bollinger band, which typically signals a trend may reverse. Bollinger bands, developed by John Bollinger in the 1980s, are used by technical analysts to identify the turning point in an asset’s trajectory.
The real’s decline has surpassed the forecasts of all but one of the analysts surveyed by Bloomberg for the second quarter. Only Morgan Stanley was looking for further declines in the real to 2.05 per dollar by June.

Currency Policy

The central bank will rely on interest-rate increases instead of propping up the currency to control inflation, according to Gustavo Arteta, a foreign-exchange strategist for Latin America at UBS AG. The real’s drop is in line with other currencies, reflecting a stronger dollar trend rather than a weaker Brazil currency against its peers, he said.
“I don’t see it coming in at these levels,” Arteta said in a telephone interview from Stamford,Connecticut.
All five economists surveyed by Bloomberg expect the central bank to lift the target lending rate by a quarter-percentage point to 7.75 percent at its May 28-29 policy meeting.
The central bank raised its benchmark rate last month for the first time since July 2011, increasing it from a record low 7.25 percent amid signs that inflation is undermining Brazil’s economic recovery.
Consumer prices rose 6.49 percent in the 12 months through April, following an increase of 6.59 percent through March. Policy makers target inflation at 4.5 percent, plus or minus two percentage points. Inflation has stayed above the midpoint target since August 2010.
“The central bank is vigilant and will do what’s needed, in a timely way, to put inflation in a declining trend in the second half, and to ensure that that trend will continue next year,” Tombini said in Rio on May 16.

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