The prices of Brazilian assets over the past week highlighted the sensitivity of financial agents to the country’s fiscal policy. Despite the Central Bank’s intervention in the exchange rate to try and curb dysfunctions, stress did not dissipate easily. The easing of the risk premium for the Brazilian real and other assets was only seen following parliamentary approval of a more austere approach to public finances with the passage of a spending review package, along with signals that the government is willing to discuss new measures to steer public debt toward a more sustainable path.
The first sign came on Tuesday when Lower House Speaker Arthur Lira announced that fiscal package bills would be put to a vote, which helped calm the markets and moved local assets away from their worst points of the day. At that time, even after the Central Bank’s interventions in the currency market with dollar sales in the spot market, the foreign exchange rate had peaked at R$6.20 per dollar but ended the session with a mere 0.02% increase, trading at R$6.0956. The currency’s volatility has also been exacerbated by the scarcity of dollars in the spot market, which is common at this time of year.
On Wednesday, with indications that the fiscal package would be diluted, domestic assets suffered again, and the Fx rate reached R$6.26 at the end of the session. The following day, Thursday, the Central Bank conducted its largest daily intervention in the spot currency market, injecting R$8 billion, with a $5 billion sale auction announced by the monetary authority after the FX rate surged to R$6.30 at its peak that day. Only after this did the currency’s dynamics see significant relief, aided by the approval of fiscal package bills in the Lower House.
On Friday, a video of President Lula suggesting the possibility of new fiscal measures if necessary was well received, leading the FX rate to deepen its losses and end the session at R$6.0719, a decrease of 0.81%. This underscores the sensitivity of the foreign exchange market to public debt trajectory and fiscal discussions.
“Since we are still facing a relatively complicated fiscal year in 2025 and possibly in 2026, it gives us the sense that we might still see high fiscal uncertainty, and thus we will continue trying to understand how it will be reduced through new actions announced by the Executive branch and approved by Congress,” said Mauricio Une, head of macro strategy for South America at Rabobank, whose forecast points to the FX rate at R$5.94 per dollar by the end of next year.
“We had a video from the president that suggests we might see the announcement of new measures, but it is still too early to understand what these measures would be and how they could reduce fiscal uncertainty and help the fiscal framework between 2025 and 2026,” he said.
In this regard, Santander economists led by Ana Paula Vescovi, a former Treasury secretary, wrote that the recent behavior of the Brazilian real “serves as an example of the limitations of exchange rate analyses that only consider interest rate differentials.” According to the bank, there are two distinct regimes: “In times of worsening perception of Brazil’s risk, the correlation becomes positive; and the rise in interest rates attracts currency inflows and strengthens the Brazilian real against the dollar when accompanied by less uncertainty.”
Santander notes that the “shock” of a 300-basis-point hike in the Selic policy rate signaled by the monetary authority last week was accompanied by a depreciation of the real due to the absence of signs that the fiscal stance would change. “Some models suggest an excessively high exchange rate, but the vicious cycle between economic policies, which could be exacerbated next year, leads us to revise the projections,” the professionals say. Santander now expects the FX rate to reach R$6.10 per dollar by the end of this year and R$6.00 by the end of 2025.
