FX Weekly Summary (Brazil Issue)

The real/dollar pair continues its trajectory, amending its sixth consecutive week of decline by closing Friday’s session (18) at BRL 5.142, a variation of -1.9% for the week and -7.7% for the year. The dollar index ended Friday's session at 96.1 points, practically stable for the week and gaining 0.5% for the year. The Brazilian real strengthens against the dollar even in a challenging international environment, driven by a strong foreign appetite for domestic assets. On the international scene, the highlights were the alternating tensions and appeasements between Russia and Ukraine, causing strong volatility in international financial markets.

Foreign scenario

This week, the focus will be on tensions between Russia, Ukraine, and the North Atlantic Treaty Organization (NATO). The belligerence continues to worsen, with the diplomatic blitz between various Western and NATO countries unsuccessful in significantly reducing hostilities. This week, Russia expelled the United States' second top diplomat in its country, Deputy Chief of Mission Bart Gorman. According to a press release, the Kremlin expelled the diplomat in retaliation for the US decision not to renew the visa of a "minister-counselor" from its embassy in the US, without offering further details, forcing his replacement. At the same time, the US State Department, for its part, called the measure "without cause."

US President Joe Biden accuses Russia of simulating a fake confrontation to justify an invasion into Ukrainian territory. “Every indication we have is they’re prepared to go into Ukraine.”, said Biden. US Secretary of State Anthony Blinken, speaking this week at a meeting at the United Nations (UN) to discuss the crisis between Russia and Ukraine, laid out the scenarios that US intelligence considers most likely in which Moscow would justify an invasion. ‘This could be a violent event that Russia will blame on Ukraine,” Blinken stated. “It could be a fabricated so-called terrorist bombing inside Russia, the invented discovery of the mass grave, a staged drone strike against civilians, or a fake – even a real – attack using chemical weapons.” Russia can describe this as ethnic cleansing, or genocide," he continued. Russian Deputy Foreign Minister Sergei Vershinin condemned the US secretary's comments, said they were regrettable and dangerous, and reaffirmed that Russian soldiers were returning to their bases. The eastern Slavic country even distributed a letter addressed to the UN Security Council in which it accuses Ukrainian authorities of exterminating Russian civilians in the east. In Ukraine, increasing ceasefire agreement violations were recorded by the Organization for Security and Cooperation in Europe (OSCE). Last Thursday, the Organization recorded 591 violations between the independent regions of Luhansk and Donetsk, of which 316 were explosions, with the image of a kindergarten hit by a mortar in a town near Luhansk resonating in financial markets.

It is becoming increasingly uncertain what the way out of this difficult standoff will be, but there is still the possibility of a peaceful solution. Anthony Blinken has accepted an invitation to meet with Russian Foreign Minister Sergei Lavrov next week, provided there is no Russian invasion. Unfortunately, the US strategy publicly denounces all available intelligence about a possible Russian invasion while persisting in laborious diplomacy of little advance. Still, little retreat, seemingly betting that Moscow will not act more aggressively while talks continue.

As a result, volatility in the asset markets has been pronounced, with a tendency toward greater caution. On days of some progress in trading, market players show greater risk appetite and invest in equities, commodities, and exotic currencies. Conversely, on days of greater tension or threats, there is a return to assets known to be safe havens in unstable times, such as gold, government bonds, and currencies like the dollar, the Swiss franc, and the yen, as well as hurting European assets and driving up the prices of energy commodities.

Besides the European geopolitical crisis, the release of the Personal Consumption Expenditure Price Index (PCE) next Friday (25) also deserves a highlight, the indicator most used by the Fed to track price acceleration. The median of the estimates shows an increase of 0.4% in January, which would raise the accumulated indicator in 12 months from 5.8% to 6.2%. The acceleration of prices in the United States is high, widespread, and persistent, motivating the Federal Reserve (Fed) authorities to publicly debate whether it would be more appropriate to raise interest rates by 0.25 percentage points or 0.50 percentage points in the monetary policy decision in March. The PCE reading may help bias that debate if it exceeds expectations.

Domestic Scenario

This week holds the release of some important national indicators. First, on Thursday, the statistics for the labor market in January will be released, emphasizing the unemployment rate and average labor income. Reductions are expected for both indicators. Also expected for the coming days are the consolidated data for January External Sector and Fiscal statistics, which will be released on February 23 and 25, respectively. In addition, inflation figures measured by the National Broad Consumer Price Index-15 (IPCA-15) from IBGE and the General Price Index - Market (IGP-M) from FGV will be released. 

After advancing 0.58% in January, surprising analysts, but slowing down compared to December, the IPCA-15 should remain on the market's radar, which uses the indicator to form expectations for the duration and intensity of the cycle of Selic hikes. Furthermore, the recent oscillations of international oil prices, following the geopolitical malaise between Russia and Ukraine, and the excess of rainfall in several regions of Brazil, offer risks of an increase in the prices of fuels and fresh food. Given the high weight of these categories in the constitution of the indicator, one can assume a bias towards sustaining or accelerating consumer inflation in February. 

The IGP-M, which attributes 60% importance to wholesale prices, has factors that can contribute both to an acceleration and a cooling of the index. On the one hand, there is a rise in international oil prices, mentioned above, and iron ore due to stimulus to the steel sector in China. However, on the other hand, the significant exchange rate appreciation during the year 2022 represents lower costs for imported inputs, which may reflect lower prices in the index.

In the political agenda, it is expected for next week the resumption of discussions in Congress about the Bill (PL) 1472/21, which creates a fund for the stabilization of oil derivative prices and a crude oil export tax, and about the Complementary Bill (PLP) 11/20, which modifies the rule of ICMS tax substitution for fuels. Both proposals would be voted on this week in the Senate but postponed their consideration to this week. 

The decision to postpone the vote was made jointly by the presidents of the Chamber of Deputies, Arthur Lira (PL-AL) and Rodrigo Pacheco (DEM-MG), searching for consensus and avoiding a long and back and forth process between the two houses. The path followed by Congress also completely rules out the possibility of the changes being implemented through a proposed constitutional amendment (PEC), as intended by the government. At the beginning of the month, representing the Planalto Palace, congressman Christino Áureo (PP-RJ) presented a PEC that would allow the Union, states and municipalities to reduce taxes on fuel and cooking gas between 2022 and 2023 without the need for a counterpart to maintain tax collection.

In addition to the fuel price stabilization measures, next Wednesday (23), the reading of the opinion on PEC 110/19, which deals with tax reform, is expected at the Senate Constitution and Justice Committee. The announcement was made by the rapporteur, Senator Roberto Rocha (PSDB-MA), after meeting with Rodrigo Pacheco and representatives of the national retail trade. 

The PEC provides for establishing a dual Value Added Tax (VAT), separating the rates intended for the federal government from those that make up the tax revenue of states and municipalities, with the electronic collection. The federal VAT would replace the collection of IPI, PIS and Cofins, while the state and municipal VAT would take the place of ICMS and ISS. Dual VAT is considered a safer option from the legal perspective as it would avoid questions based on the tax autonomy of federal entities provided for in the Constitution.