FX Weekly Overview (Brazil Issue)

Dollar to reflect Brazilian electoral scenario and interest rate decisions by FOMC and Copom

The week in review

• During the week, signals of a narrowing gap between President Lula and Flavio Bolsonaro in voter intentions generated optimism among investors and strengthened the Brazilian real.
• Additionally, amidst the institutional crisis in the Supreme Federal Court (STF), the confidentiality of all investigations related to Banco Master was lifted. Investors are seeking to assess potential impacts of these investigations on the electoral race.
• In the US, August readings of producer inflation (PPI) and consumer inflation (CPI) accelerated in line with estimates, driven by fuel prices, reinforcing the perception of persistent inflationary pressures.

USDBRL Variations | Daily: +0.53% | Weekly: -0.10% | Monthly: -1.09% | Yearly: -6.43% | In 12 months: -4.93%
Dollar Index Variations | Daily: +0.07% | Weekly: -0.01% | Monthly: -0.28% | Yearly: +0.82% | In 12 months: +1.65%

KEY EVENT: Brazilian Political and Electoral Scenario

Expected Impact on the USDBRL: Bearish

In the domestic electoral scenario, investors are expected to closely monitor presidential voter intention polls to identify potential impacts of the institutional crisis in the Supreme Federal Court (STF) and its repercussions on the electoral campaigns.

• Between Monday (14) and Tuesday (15), three polls for presidential voter intentions will be released, which should reflect the latest national news.

Why this matters: A tight electoral race could reduce predictability regarding Brazil's economic policies for the next four years, increasing the perception of risks for Brazilian assets, amplifying volatility, and harming the BRL's performance.

• In particular, recent reactions from financial market agents reveal a preference for electing a new president who could adopt a more conservative fiscal policy.
• As such, a greater perspective of government change tends to reduce the perception of risks for Brazilian assets and favor the Brazilian real's performance.

Tight Elections: Recent voter intention polls have indicated a trend of weakening President Lula's candidacy and strengthening Flavio Bolsonaro's, although the candidates remain in a technical tie.

• In the latest voter intention poll for a potential second round, Flavio Bolsonaro had 46.4% of voter intentions compared to Lula's 46.2%, constituting a technical tie.
• In recent weeks, investors have been optimistic about Flavio's favorable trend, boosting the performance of Brazilian assets.

Institutional Crisis in the STF: Amidst the institutional crisis in the Supreme Federal Court (STF), last Friday (11), the Court's President, Edson Fachin, requested Minister André Mendonça to lift the confidentiality of all investigations related to Banco Master.

• Additionally, a hearing in the STF is scheduled for next Tuesday (15) to discuss the alleged connection between Court Minister Alexandre de Moraes and former banker Daniel Vorcaro, owner of Banco Master.
• Although STF ministers are not directly connected to the Executive, investors interpret the news on the topic as favorable to Flavio's campaign, a long-time critic of the STF's actions.

Flavio Bolsonaro Investigated: Along with the material released by André Mendonça regarding the Banco Master case investigations is a request to investigate Flavio Bolsonaro for alleged crimes involving the financing of the film “Dark Horse.”

• The candidate has already stated that he spoke with Vorcaro seeking resources for the film's financing but denied any irregularities.
• Despite the release of the request, material related to the investigation remains confidential.
• Therefore, investors are calibrating their expectations to assess whether these news could impact Flavio's candidacy.

FOMC Interest Rate Decision

Expected Impact on the USDBRL: Bullish

The currency market is expected to reflect the Federal Reserve's (Fed) Federal Open Market Committee (FOMC) interest rate decision next Wednesday (16), which is likely to increase its benchmark interest rate by 0.25 percentage points.

Why this matters: The Federal Reserve's interest rate hike is expected to increase the yield on US Treasury securities (Treasuries) and attract foreign capital to the country, strengthening the USD globally.

High Inflation Risks: Both the Consumer Price Index (CPI) and the Producer Price Index (PPI) accelerated in August in line with expectations, driven by rising fuel and other petroleum derivative prices.

• The core CPI, which excludes more volatile food and energy components, rose 0.3% in August, above the median estimate, while service prices excluding housing also rose more than expected at 0.5%.
• This reading suggests that inflationary pressures remain persistent and widespread in the United States.
• Additionally, the prospect of prolonged logistical restrictions in the Persian Gulf has pushed international oil prices back above USD 100 per barrel, signaling that energy costs are likely to remain high for longer.
• Meanwhile, stronger numbers from the August Employment Situation Report point to a healthier and more stable labor market, reinforcing that the US economic risk balance is more inclined toward inflation than unemployment.

Probable Interest Rate Hike: For this reason, recent economic indicators have solidified investor bets that the FOMC will raise its interest rate from the range between 3.50% and 3.75% per year to the range between 3.75%.

• Adding to these bets is the firmer stance taken by Fed Chairman Kevin Warsh in his speech at the Jackson Hole Symposium, when he described an asymmetrical risk balance tilted toward inflation even before the latest data.
• Warsh suggested that the US central bank could raise interest rates if inflation in the country is not returning to the 2% annual target "clearly and at a sufficient speed."
• Recent CPI and PPI readings would hardly meet Warsh's criteria for price stabilization.
• Given this context, a hypothetical choice by the Federal Reserve not to increase interest rates in this decision would likely provoke the same negative reaction observed in the July decision, possibly even more intense.

Warsh Likely to Have Majority: In terms of Committee dynamics, Warsh is expected to find it relatively easy to secure a majority (seven votes) for the interest rate decision, whether it be a pause or a hike.

• It is practically unthinkable for the Fed's Vice Chairman (Philip Jefferson) or the President of the New York Fed (John Williams) not to align their votes with the Fed Chairman's, as they are the most senior leaders.
• It also seems highly unlikely that Jerome Powell, the former Fed Chairman, would vote differently from Warsh, as he pledged to be a discreet member following Warsh's swearing-in.
• This totals 4 votes in the same direction. Since, in the July decision, five other members voted to maintain interest rates and three voted for an immediate hike, Warsh is likely to convince at least three additional colleagues to support his vote.

What's Next? While a rate hike in this Wednesday's decision seems certain, there is considerable doubt about the Fed's next steps.

• Warsh is a notorious critic of forward guidance and refuses to comment on scenarios and alternatives for monetary policy, so he likely won't indicate whether further rate hikes will occur in the short term.
• Nevertheless, investors are betting on a sequence of rate hikes by the Fed, with three more increases expected by the end of 2027.

Copom Decision

Expected Impact on the USDBRL: Bullish

On Wednesday (16), the Monetary Policy Committee (Copom) of the Central Bank (BC) is expected to reduce the benchmark interest rate (Selic) by 0.25 percentage points, from 14.00% to 13.75% per year.

• According to projections from the latest Focus Bulletin, this would be the last Selic adjustment of the year.
• However, investors are looking for signals from the monetary authority regarding the possibility of further cuts this year.

Why this matters: The reduction of the benchmark interest rate (Selic) is expected to lower the yield on domestic securities and hinder the attraction of foreign capital to the country, weakening the BRL.

Inflation and Economic Activity Favor Cuts: August's reading of the National Consumer Price Index (IPCA) was favorable, indicating a slowdown in 12-month inflation from 4.44% to 4.22%, closer to the target center.

• The core of the indicator, which excludes volatile food and energy components, also showed relief in inflationary pressures, decelerating from 0.25% to 0.20%.
• Additionally, recent months have shown signs of slowing economic activity. GDP growth in the second quarter slowed from 1.10% to 0.5%, reducing 12-month growth from 2.00% to 1.90%.
• The moderation of inflation and economic activity in recent months has reinforced bets on another Selic cut by Copom.
• However, significant risk factors for the coming months could lead to an interruption in the adjustment cycle.

Inflationary Risk Factors: With the recent escalation of tensions in the Middle East, Brent prices have risen over 15% this month, returning to the USD 100 per barrel level, heightening concerns about global inflationary pressures.

• Domestically, the unemployment rate stands at 5.3%, near historic lows, favoring the reading of a robust labor market and potential inflationary pressures stemming from stronger demand.
• Finally, projections of a strong El Niño later this year may also increase the monetary authority's caution, as the phenomenon has the potential to affect agricultural production.

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