US Interest Rates and the Brazilian Exchange Rate
Since 2022, the movements of the Real have closely followed the variations of the Dollar Index, which in turn reflects betting on the movements of the fed funds rate. Although the market wager on an early start of the easing cycle in the United States was strengthened by the comments of Jerome Powell at the press conference after the last FOMC meeting, the latest data about retail sales and the labor market have triggered higher projections for GDP growth.
With the economy still resilient and inflation far from the target, the probability has grown that the Fed will only start the easing cycle on the second half of 2024. When this cycle begins, the weakening of the dollar should contribute to appreciation of the Real, but in the short run, a contrary force exists, namely the still strong dollar. In the remainder of this Report, we show that although the Central Bank has refrained from interventions in the spot and future currency market, the volatility of the Real has fallen markedly.
To gauge the distance of the Real from its fair value, we use our model of the real exchange rate equilibrium, which has the property of producing extremely stable estimates both in and out of sample. Using this metric, the equilibrium real exchange rate (the projections in and out of sample) have been appreciating, but the observed values are undershooting the projected ones, meaning that the strengthening of the dollar should approximate the real exchange rate in relation to our model’s projection. The proximity of the actual and projected values, along with the low volatility of the Real, indicate that barring an unforeseen event, there should be no surprises about its behavior.
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