Why hasn’t the weakening of the Dollar strengthened the Real?
Between March and May 2020, the Federal Reserve reacted to the economic effects of the pandemic by reducing the fed funds rate to 0.25% a year (technically equal to zero) and purchasing more than US$ 2 trillion worth of Treasuries, the great majority maturing in up to 5 years. It was a monetary stimulus greater than that of other advanced countries, as well as emerging ones. These actions caused the dollar to weaken: according to the Dollar Index, since the start of the pandemic, it has weakened by a cumulative 10%.
In normal circumstances, the weakening of the dollar would contribute to strengthen the Real, or at least attenuate its depreciation. This is the indication from past experience. Indeed, between 2008 and 2012, when Brazil was generating primary surpluses sufficient to reduce the debt/GDP ratio and had investment grade rating, the movements of the Real closely followed the movements of the Dollar Index, attracting capital that exceeded the current account deficits, leading to surpluses in the balance of payments.
However, the fiscal conditions changed as of 2015, and have changed even more since the pandemic struck. Although the government claims it is pursuing fiscal consolidation based on reforms, that objective is still distant, and the risk is high (for many reasons, one of which is the continuing pandemic) that the fiscal situation will worsen. This is reflected in the slope of the yield curve and the depreciation of the Real. As has been the case of the currencies of other countries in crisis (such as Argentina, Turkey and Russia), the Real has not responded to the weakening of the dollar, and has behaved much differently than the currencies of the great majority countries, both advanced and emerging, which with varying degrees have appreciated.
With the objective of keeping expectations anchored, the Central Bank is poised to begin a tightening cycle. But this will have little or no effect on the Real. Under the current conditions of the Brazilian economy, an appreciation of the Real will only occur with fiscal consolidation, which is not yet in sight, meaning Brazil will continue living with a weak currency.
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