Forces Driving the Exchange Rate

BRAZIL ECONOMICS - Report 23 May 2016 by Affonso Pastore, Cristina Pinotti, Caio Carbone and Marcelo Gazzano

An increase in demand for Brazilian assets leads at the same time to a decline in the risk premiums (CDS quotations) and appreciation of the exchange rate. Both of these movements started occurring before the change of government, in light of the clear increase in the likelihood of impeachment, with the real reaching the neighborhood of R$3.50/US$ (Graph 1). However, even after the announcement of the new economic team, headed by Meirelles as finance minister and Goldfajn at the Central Bank, the real has continued fluctuating at the same level of R$3.50/US$, along with a certain stability of the CDS quotations. The basic reason rests on the fact that despite the excellent quality of the economic team, doubts persist regarding the political success in winning approval of the necessary structural reforms. In addition, the terms of trade are declining and indications are growing that the Federal Reserve will proceed with monetary normalization this year, although slowly. These are factors limiting the appreciation of the real.

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