FX Weekly Summary (Brazil Issue)

The exchange rate continued to depreciate for the fourth week and ended Friday's session (4) at BRL 5.325, a weekly variation of -1.2% and an annual of -4.5%. On the other hand, the dollar index ended the session at 95.4 points, a variation of 1.9% in the week and practically stable in the year. After a strong dollar rally in the previous week, this week was marked by a reversal just as abrupt due to the coordinated effort of several members of the Federal Reserve (Fed) to reduce the dispersion of estimates existing among market analysts. Also contributing to the depreciation of the American currency were monetary policy decisions by the British Central Bank, which raised its interest rate, and the European Central Bank, which kept its monetary instruments unchanged but adopted a discourse interpreted as firmer in the fight against inflation. In Brazil, a statement from the Monetary Policy Committee (Copom) signaling that it will reduce the pace of monetary tightening this year also led to a drop in the Brazilian real against the US currency, but not enough to offset its weekly gain.

Foreign scenario

This week, the focus will be on the Federal Reserve's monetary policy report on Friday. The document is sent every six months to the US Senate Banking Committee by the institution and details the Fed's view on the current economic and financial environment, the conduct of monetary policy by the US central bank and the institution's outlook for some key economic indicators, such as gross domestic product growth, unemployment and inflation rate developments and the evolution of the interest rate anticipated as appropriate for each year. The report should help reduce the current dispersion of estimates among market analysts about how the Fed should carry out the monetary tightening this year. Expectations range from three 0.25 percentage point interest rate hikes (e.g., Barclays) to seven hikes of the same magnitude (e.g., Bank of America), with most analysts anticipating four hikes.

Also noteworthy is the January Consumer Price Index (CPI) release next Thursday. In December, the accumulated indicator for 12 months accelerated to 7.1%, its highest since June 1982. With the hike in oil prices in the previous month, the possibility of an increase in the index is considerable, which should put pressure on the Fed to raise its interest rate at the next meeting in March and be more forceful in its monetary policy tightening this year.

Domestic Scenario

This week, the focus should be on the Central Bank of Brazil's Monetary Policy Committee (Copom) meeting minutes after the Committee surprised the market with a statement less rigorous than expected in the commitment to fight inflation. Despite the 1.5 percentage point increase in the basic interest rate (Selic), its eighth consecutive increase, from 9.25% per annum to 10.75% per annum, the monetary authority signaled that it foresees a reduction in the pace of monetary tightening for the next decision, without specifying what the next adjustment will be. In its communiqué, Copom emphasized that the cumulative effects will become apparent over the relevant horizon, suggesting that it should promote Selic hikes more gently but for a longer period. This strategy would be compatible with the convergence of inflation to the target "to a greater extent" in 2023, indicating that the Committee is not prone to abrupt readjustments to pursue the inflation target this year.

This stance had strong repercussions on the interest and currency markets. Future interest rates fell sharply, and bets that the Selic rate would close the year above 12.00% lost strength. Moreover, estimates for the monetary authority's next steps began to grow in amplitude: Regarding the March meeting in the digital options market, which measures the direct bets of the agents on Copom decisions, there is a concentration of bets on a 1.0 percentage point increase in the Selic; 16% possibility of a 0.75 p.p. adjustment; 10% chance of a 0.50 p.p. increase; and 7% probability of a 1.25 p.p. increase.

There is also greater dispersion as to the final level of the basic interest rate at the end of the monetary tightening cycle, with the scenarios that forecast a rate above 12.00% per annum losing strength.
Thus, the minutes of this week's meeting may bring important elements about the context of the decision and consolidate expectations around how the authority anticipates the next steps of monetary policy. Although warnings about risks and the need to observe the behavior of economic data are expected, greater clarity about the reference scenarios for the future is necessary to maintain the credibility of the institution and the good functioning of the markets.

Next week will bring important data for evaluating the economic situation, such as the volume of services and the level of retail sales in December. However, the most important data should be January's National Broad Consumer Price Index (IPCA). There are risks for both a higher and lower figure. On the one hand, January saw a significant rise in international oil prices, which led Petrobras to readjust fuel prices on January 11. In addition, the south of the country is going through a water crisis, which raises the prices of horticultural food products. On the other hand, the exchange rate appreciated 4.8% last month, which helps to reduce costs of imported inputs and may provide some relief to the price index.

Finally, it is worth noting the proposed constitutional amendment (PEC) filed this week that seeks to reduce the increase in items that most contribute to the recent acceleration of prices. On Thursday, deputy Christino Áureo (PP-RJ) filed a PEC at the Chamber of Deputies to allow the Union, States and Municipalities to reduce or zero the tax rates levied on fuel and cylinder gas in 2022 and 2023 to reduce their price without needing to comply with the Fiscal Responsibility Law (LRF), i.e., without the need to indicate another revenue or spending cut to offset the drop in tax collection. The Planalto Palace has discussed the proposal since at least January 20. The newspaper Valor Econômico revealed that the text filed by Áureo in Congress was written by the Deputy Chief of Public Finance (SAFIN) of the Civil House Ministry, Oliveira Alves Pereira Filho. As the proposal would directly benefit Bolsonaro, it could not be presented by the Executive this year due to the Electoral Law. Therefore, it would need to be presented by a congressman. According to calculations made by the Ministry of Economy - which is against the proposal -if approved, the amendment could cause losses of up to BRL 54 billion in federal tax revenues alone, not including municipal and federal entities. This amount is higher than the total public investments foreseen for 2022, of BRL 44 billion (the lowest value in the historical series).

On Friday, Senator Carlos Favaro (PSD-MT) filed another PEC, this time in the Senate, even broader, proposing to exonerate fuels, gas cylinders and electricity, create a diesel aid for truck drivers, subsidize low-income families to buy gas, and generate a transfer of federal funds for urban mobility for the elderly. Since all these measures would be carried out without fiscal compensation, the initial estimate is that the loss of federal revenue will be BRL 100 billion. According to press reports, the Ministry of Economy has dubbed Fávaro's version as the "PEC of fiscal irresponsibility" and "PEC kamikaze" (aimed at reducing fuel prices).
The constant changes in the budget and government priorities with a clear focus on the October election reduces the government's credibility and increases the financial risk, which can increase investors' risk premium requirements and weaken the Brazilian currency. In its last statement, Copom warned that "fiscal policies that imply an additional boost to aggregate demand or worsen the future fiscal path may negatively impact important asset prices and raise the country's risk premiums.