Analysts predict limited relief for Brazilian real (2024)

After a period of volatility that saw the foreign exchange rate peak at R$5.70 per dollar, the highest since January 2022, the real has experienced three consecutive sessions of appreciation, settling just below the technical threshold of R$5.50 per dollar. This downtrend was influenced by government indications of spending cuts and weaker economic indicators from the United States. Despite this, market consensus suggests that the Brazilian currency will not fully recover from the recent depreciation, with expectations that the FX rate will maintain higher levels.

Last week, the spot dollar saw a 2.27% decline in Brazil, closing at R$5.4618 on Friday. This modest rebound in the real occurred amidst President Lula’s cautious remarks on the fiscal agenda and Central Bank monetary policies, alongside Finance Minister Fernando Haddad’s announcement of a potential R$25.9 billion reduction in mandatory expenditures for the 2025 budget.

The weakening of economic activity and the labor market in the United States also contributed to the real’s recent gains. Notably, the Institute for Supply Management (ISM) Purchasing Managers’ Index (PMI) for the services sector dropped to its lowest level since 2020, and the official U.S. labor market report indicated a slowdown in net hiring in June.

Despite these factors, the recovery of the real is not expected to extend much beyond recent gains. Several brokerage houses have adjusted their FX rate projections upward due to persistent local fiscal uncertainties and signals from the U.S. Federal Reserve (Fed) indicating reluctance to start a cycle of interest rate cuts soon. For instance, XP has revised its year-end FX projection from R$5 to R$5.40. Similarly, Santander adjusted its forecast from R$5 to R$5.30, and the consultancy Buysidebrazil moved its prediction from R$5.20 to R$5.40.

C6 Bank has adjusted its forecast for the FX rate to R$5.50 per dollar by the end of this year, a revision from their earlier prediction of R$5.30 in January. According to the bank’s chief economist, Felipe Salles, C6 has consistently anticipated a weakened real. The question was whether the currency would reach the level of our current forecast by 2024. “Apparently, it did,” he commented in an interview with Valor.

Mr. Salles believes that the government’s recent signals of spending cuts for 2025 are a step in the right direction. However, he remains skeptical about the execution of these cuts and whether the measures will suffice to keep spending within the bounds set by the fiscal framework.

“If it’s successful, it might help calm the FX rate a bit more,” suggests Mr. Salles, though he acknowledges ongoing concerns. “Compulsory spending is growing steadily, so to fit it within the fiscal framework’s limit, discretionary spending would need to be significantly constrained, and it’s questionable whether that’s feasible,” he explains.

Echoing this caution, José Faria Junior, partner and director at Wagner Investimentos, expresses even greater skepticism about the spending containment measures discussed by Minister Haddad, likening them to “sticking a band-aid on” fiscal woes. “It’s crucial for President Lula and Minister Haddad to claim they will do whatever it takes to comply with the framework, but the proposals don’t seem to have long-term sustainability,” he remarks.

Looking ahead, if upcoming U.S. inflation data show continued easing, Mr. Faria Junior anticipates that the FX rate could drop further, potentially fluctuating between R$5.30 and R$5.40 per dollar. However, he views this range as a new baseline for the domestic exchange rate, indicating no expectation for it to drop significantly below these levels.

In Mr. Salles’ perspective, the most likely scenario is that the U.S. economy slows down without significant impacts on the labor market, a “soft landing” where the Fed will not rush to loosen monetary policy. According to him, the risk of a recession in the U.S. is still minimal, with no basis for expecting more than the two 0.25-point rate cuts currently anticipated by investors for 2024.

Mr. Faria Junior, however, views the situation differently. He points to various qualitative indicators and direct elements of the real economy that suggest a potential recessionary trend, which might catch the Fed off guard. Moreover, as U.S. presidential election risks begin to dominate market considerations, he anticipates potential strengthening of the dollar, especially if the current favorability for Republican Donald Trump solidifies by November. “The dollar is highly valued, but [a victory for] former president Trump suggests a stronger dollar,” he notes.

Mr. Salles points to a potential election of the Republican candidate as a factor that could exert pressure on long-term interest rates in the U.S. This pressure would stem from proposed tax cuts and increased trade tariffs, which are likely to exacerbate the already strained U.S. fiscal deficit and could induce inflationary pressures. While he acknowledges that higher long-term interest rates in the U.S. typically strengthen the dollar, he notes that previous statements by Mr. Trump opposing currency appreciation inject uncertainty about the election’s impact on exchange rates.

Translation: Todd Harkin

Analysts predict limited relief for Brazilian real (2024)

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