Brazilian Real Bears Foiled by Presidential Election

Brazilian real bears are being hurt by President Dilma Rousseff’s bid to use the currency to tame inflation before elections in October.

The real has jumped 6.8 percent this year against the dollar, the best performance among the 16 most-traded currencies, just as options traders step up bearish bets to near a record.

Banks from Citigroup Inc. to Banco Bilbao Vizcaya Argentaria SA say policy makers looking to end the world’s longest stretch of borrowing cost increases will rely instead on a stronger currency to ease inflation. Consumer-price increases quickened to more than 6 percent last month as the worst drought in a half-century drives up food prices, contributing to Rousseff’s decline in the polls before the vote.

“Currency management is likely to play a part in the government’s policy strategy as the election approaches,” Michael Henderson, an analyst at Maplecroft Global Risk Analytics in Bath, England, said in an e-mailed response to questions April 10. “I have no doubt that Rousseff and company will dip into the unorthodox toolkit to do whatever it takes to stop inflation.”

The real rose 0.8 percent last week to 2.2187 per dollar in its fourth straight rally, the longest stretch of gains since February 2013. Its advance this year is bigger than any quarterly increase since the three months ending September 2010, when it climbed 7 percent. It appreciated 0.1 percent to 2.2160 per dollar today at 3:30 p.m. in New York.

2 Per Dollar

Henderson forecasts authorities will steer the currency to as strong as 2 per dollar this year, reaching that level the first time since May.

Analysts at Citigroup and BBVA say the central bank is using its intervention program of currency swap auctions to support the real and combat inflation by limiting import price increases. Brazil has been selling as much as $200 million in daily foreign-exchange swaps under a program announced in December. The currency surged the most in emerging markets on April 4 when the central bank resumed rolling over the contracts.

“At this moment, the only ally the central bank has to act in the fight against inflation is the appreciation of the currency,” Mario Toros, a partner at Ibiuna Investimentos and a former central bank monetary policy director, said at an event in Sao Paulo on April 10.

Monetary Policy

The central bank signaled following its April 1-2 policy meeting that it will bring an end to its rate increases, which have been unpopular with voters ahead of election day. Policy makers reiterated in minutes of their April meeting that the increase in borrowing costs has yet to work its way through the economy, adding to speculation that they are phasing out monetary tightening and will find other ways to fight inflation.

The central bank and Finance Ministry press offices declined to comment on the government’s currency strategy.

The central bank slowed the pace of increases in the target lending rate to a quarter-percentage point in April and February after raising it twice as fast at each of the six prior meetings. The nine increases since April 2013, which brought the so-called Selic to 11 percent, are the most among 49 central banks tracked by Bloomberg.

Drought Impact

Cloudless skies are making it tougher for Rousseff to contain annual inflation that has remained above the midpoint of the central bank’s target since her term began three years ago. The lack of rain triggered a spike in food prices in March, when they soared 1.92 percent from the month before, and is crimping water and energy supplies as Brazil prepares to host the World Cup in June. Consumer prices rose 6.15 percent in the 12 months through March, the fastest pace since July, the national statistics agency reported last week.

Foreign investors increased bets the real would decline by 33 percent last week to $27.7 billion, the biggest such increase since September, according to data from BM&FBovespa, South America’s largest exchange. The bearish wagers are approaching a record high of $28.1 billion reached in January.

While inflation has accelerated, economic growth eased to an average 2 percent during Rousseff’s first three years in office. That is the slowest pace for a Brazilian president since Fernando Collor, who resigned in 1992 after allegations of corruption

Inflation and the economic slump are signs that the real’s rally won’t last, according to Vladimir Caramaschi, the chief strategist at Credit Agricole Brasil SA in Sao Paulo. Standard & Poor’s lowered Brazil’s credit rating on March 24 to the lowest investment grade, saying the sluggish growth and an expansionary fiscal policy are fueling an increase in the country’s debt.

Currency Forecasts

“Fundamentals are not good,” Caramaschi said in an April 9 phone interview. “A stronger real would further weaken growth, which the government is concerned about and will look to avoid.”

Caramaschi said the real will weaken this year to 2.5 per dollar, in line with the median forecast of 2.48 among 44 economists surveyed by Bloomberg.

The real’s appreciation this year has conjured less of a reaction from government officials than past rallies.

Brazil started imposing restrictions on capital flows in 2010 after Finance Minister Guido Mantega accused the U.S., Japan and Europe of sparking a currency war by pushing interest rates toward zero and driving investors to emerging markets. The real strengthened to a 12-year high of 1.529 per dollar in July 2011 in a rally that Mantega called a “disaster” for local manufacturers.

Changed Tack

Brazil began abandoning policies to depress the exchange rate last year and moved to support the real with swap auctions after the currency fell to a four-year low of 2.4549 per dollar, a level it almost reached again in January.

“You don’t have a finance minister coming out who is usually more vocal on the exchange rate,” Kenneth Lam, a strategist at Citigroup, said in an April 10 phone interview from New York. The central bank “has shifted to using FX as a tool to fight inflation.”

The real has also been supported by Rousseff’s slide in the polls as investors bet she could lose the vote to an opposition candidate who would intervene less in the economy.

The currency rallied on April 7 after Rousseff’s support fell to 38 percent this month from 44 percent in February in a Datafolha poll that pitted her against opposition candidates. The April 2-3 survey of 2,637 people had a margin of error of plus or minus 2 percentage points.

A survey published in March by CNI-Ibope showed her approval rating dropped for the first time since July, when street protests triggered by a bus fare increase pushed her popularity to a record low.

Inflation Policy

Seventy-one percent of those surveyed disapproved of Rousseff’s inflation policy, compared with 63 percent in November. The survey of 2,002 Brazilians from March 14 to 17 had a margin of error of plus or minus 2 percentage points.

Enestor dos Santos, an economist at BBVA, said Rousseff is being forced to use the real to avoid a revival of last year’s protests, which came as inflation breached the 6.5 percent ceiling of the central bank’s target range. Moves in the currency have a faster impact on inflation than interest rate moves or budget cuts, he said.

“It takes time to drive inflation down, even if you use monetary or fiscal policy,” Santos said in an April 9 phone interview from Madrid. “The expectation is that inflation will breach the central bank’s target range this year, and the discussion is now turning to whether it will even slow by year’s end. So the government will have to keep the real strong.”

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