FX Weekly Overview (Brazil Issue)

Dollar expected to reflect Copom minutes, US inflation data, and concerns about national economic policy

The week in review

• Throughout the week, the BRL remained under pressure due to uncertainty about the economic policy of Lula's fourth term, with speculation about interference in the basic interest rate (Selic) increasing the risk perception of national assets.
• Brazil's Monetary Policy Committee (Copom) held the Selic rate at 13.75% per year and adopted a conservative tone in its statement, helping to keep inflation expectations anchored and mitigating losses in national assets.
• Externally, the Democratic victory in the midterms reinforced the prospect of roadblocks to Trump's agenda and regulations on the artificial intelligence sector, fostering a risk-averse environment that hurt emerging market currencies.

USDBRL variations | Daily: +0.35% | Weekly: +1.09% | Monthly: +1.09% | Annual: +0.60% | 12 months: +3.00%
Dollar Index variations | Daily: +0.76% | Weekly: +0.37% | Monthly: +0.37% | Annual: +4.06% | 12 months: +2.59%

KEY EVENT: Copom Minutes

Expected impact on the USDBRL exchange rate: bearish

On Tuesday (10), the Monetary Policy Committee (Copom) will release the minutes from its last decision, which kept the basic interest rate (Selic) at 13.75%, interrupting a streak of five cuts.

• Amid elevated uncertainty surrounding economic policy direction over the next few years under Lula's government, combined with inflationary risks and economic slowdown, the Copom adopted a neutral tone in its statement after the decision, leaving future steps open.
• In this context, the minutes will be important for better understanding the Committee’s economic outlook, helping investors adjust their expectations.

Why this matters: If the document reinforces Copom’s neutral tone and cautious stance, investors are likely to increase bets on halting the interest rate cutting cycle, raising domestic bond yields and attracting foreign capital, which tends to support the real’s performance.

• Additionally, amidst uncertainties about fiscal policy management over the next four years, a more cautious monetary policy is likely to limit inflation expectations’ deviation and soften losses in national assets.

Challenging inflation scenario: In the statement issued post-decision, Copom raised its inflation projections for accumulated inflation in 2026 and 2027 to 5.6% and 4.7%, respectively, further deviating from the target’s midpoint.

• Besides the increase in projections, the statement highlighted the challenging inflation scenario, with an acceleration in core inflation measures, prolonged high crude oil prices, and a still-resilient labor market.
• Additionally, the Committee mentioned the unanchoring of inflation expectations, without attributing this to Lula’s re-election.
• Finally, although the statement does not mention it, strong El Niño forecasts until the first half of 2027, impacting food prices, and the recent exchange rate depreciation add to the inflation control challenge.

Signs of economic slowdown: Alongside the challenging inflation scenario, recent indicators reinforce perceptions of economic cooling.

• On this, Copom describes a “sharper slowdown” due to a “substantially contractionary” monetary policy.
• In recent decisions, despite inflation remaining above target, perceptions of economic weakening prompted the rate-cutting cycle.
• However, with deteriorating investor expectations, the Committee opted to pause the cycle and adopt a more cautious stance, halting the sequence of economic stimuli observed in recent months.

Stagflation risk? In this context, Copom faces opposing risks that cannot be mitigated simultaneously.

• On one hand, the challenging inflation scenario and risks of unanchored investor expectations call for tighter monetary policy to stabilize prices.
• On the other hand, intensified economic slowdown demands lower rates to stimulate production and demand.

• The possibility of an economy with high interest rates, elevated inflation, and economic slowdown—i.e., stagflation—complicates monetary policy, forcing Copom to choose the greater risk to address.

• In its last decision, the Committee determined it was more urgent to avoid further unanchoring of inflation expectations, choosing to keep the Selic unchanged and reaffirm its cautious stance.

IPCA: In this regard, on Thursday (12), investors are expected to react to October’s Consumer Price Index (IPCA) reading, which should indicate a monthly inflation drop from 0.82% in September to 0.30% in October.

• Despite representing a slowdown compared to the previous month, the 12-month accumulated inflation should rise from 4.58% to 4.80%, moving further away from the 4.50% target ceiling.
• For core inflation, excluding volatile items like food and energy, an increase between 0.30% and 0.40% is expected, reinforcing the perception of widespread inflationary pressures and bolstering bets on halting the Selic rate-cutting cycle.

Concerns about Brazilian economic policies

Expected impact on the USDBRL: bullish

Investors are expected to continue reacting to the pessimistic and skeptical sentiment surrounding economic policies during President Luiz Inácio Lula da Silva’s fourth term, closely monitoring signs about fiscal policy management and the composition of his economic team.

• These decisions, however, are expected to be postponed until after November 17, when Lula returns from trips to Turkey and the Philippines.

Why this matters: Investors anticipate a more expansionary fiscal policy under Lula’s new government, leading to a faster acceleration of national debt levels.

• As a result, there is an increase in the perception of fiscal risks for Brazilian assets and higher investor risk premiums, which tend to weaken the BRL.

Lula’s address: To alleviate financial market concerns, Lula recorded a national address to be aired on Sunday (08).

• In the address, the president is expected to emphasize his commitment to fiscal responsibility without announcing concrete measures.
• Additionally, Lula is expected to reaffirm his promise to maintain and expand social policies in his upcoming term.

Rumored proposals: Media reports indicate the government is debating the possibility of adopting the fiscal target center for resource contingency, increasing the base of expenses subject to contingency by 20%, and reducing the maximum limit for the annual real growth of expenditures.

• Additionally, it has been reported that the government is considering taxing income-tax-exempt securities, such as LCAs, LCIs, CRAs, CRIs, and incentivized debentures.
• This measure would be implemented by changing the Tax on Financial Transactions (IOF) rate through a decree, bypassing Congressional voting and potential rejection.
• The set of measures aims to achieve a primary surplus of 1.5% of GDP by the last year of the new term.

US inflation data

Expected impact on the USDBRL: bullish

Abroad, the currency market is expected to react to the release of the US Consumer Price Index (CPI) and Producer Price Index (PPI) for October, the final readings before the Federal Reserve’s December 9 interest rate decision.

• Although a slowdown in the monthly increases of both indices is anticipated, it is unlikely to change the perception of a risk balance inclined toward inflation.

Why this matters: The readings for CPI and PPI are expected to reinforce the perception of a risk balance inclined toward inflation, increasing bets on interest rate hikes by the Federal Reserve in the coming months.

• This, in turn, tends to raise yields on US Treasury bonds and attract foreign capital to the country, strengthening the dollar globally.

Estimates: The median estimates for CPI suggest the monthly variation should decrease from 0.6% in September to 0.3% in October, while the monthly variation of the core indicator, excluding volatile components like food and energy, should drop from 0.3% to 0.2% during the same period.

• This core moderation is expected to be driven by a more contained rise in used car prices, electronic consumer goods, and rent prices.
• Even so, if these projections are confirmed, the 12-month accumulated increase would rise from 3.7% to 3.9% for the full index and from 2.6% to 2.7% for its core.
• The median estimate for PPI suggests the monthly variation should decrease from 1.3% in September to 0.4% in October, and from 0.7% to 0.3% for its core.
• This result would raise the 12-month PPI increase from 6.3% to 6.6% for the full index, while the core would remain at 5.0%.

Inflation risks: While a slowdown in the monthly increases of both indices is anticipated, it is unlikely to change the perception of a risk balance inclined toward inflation.

• First, because they are insufficient to suggest a trend of price stabilization.
• Additionally, the prospect of prolonged oil and derivative shortages due to geopolitical conflicts, and semiconductor shortages due to the rapid expansion of artificial intelligence infrastructure, are expected to sustain higher cost pressures on the US economy.

Heated economy: The perception of a risk balance inclined toward inflation in the United States is further reinforced by the strong performance of productive activity and labor market indicators.

• Last week, the Purchasing Managers' Index (PMI) for manufacturing accelerated from 54.5 points in September to 55.5 points in October, while the services PMI decelerated from 54.9 points to 54.5 points over the same period (readings above 50 indicate expansion).
• These numbers signal stronger productive activity expansion, consistent with the first preview of the US Gross Domestic Product (GDP) for the third quarter, which accelerated its annualized quarterly growth rate from 2.2% to 3.4%, driven by consumption and investment increases.

Stronger-than-expected payroll: The Employment Situation Report indicated a net creation of 165,000 jobs in the US in October, well above the median estimate of 62,000.

• Additionally, net job figures for August and September were revised upward, showing 84,000 more jobs than initially reported.
• The unemployment rate, in turn, decreased from 4.2% to 4.1%, also better than projected.
• Job gains were well distributed across sectors, with highlights in domestically driven segments such as construction and manufacturing.
• These numbers indicate faster-than-expected labor market expansion, which could lead to more accelerated consumption growth and, in turn, create a new source of inflationary pressure on the economy.

INDICATORS