Interest Rates in the USA, Term Premium and Reflections on Brazil

BRAZIL ECONOMICS - Report 27 Nov 2023 by Affonso Pastore, Cristina Pinotti, Paula Magalhães and Diego Brandao

Since Brazil is integrated in international capital flows, the Central Bank’s monetary policy decisions must consider what happens in the United States, and to clarify the importance of this fact, nothing is better than an example. In 2020, against the backdrop of the pandemic, the Federal Reserve lowered the interest rate to the zero lower bound and simultaneously purchased US$ 4.5 trillion worth of assets, doubling the size of its balance sheet.

This caused the dollar to weaken, in turn prompting the strengthening of the 12 currencies listed in the box associated with Graph 1. Similar appreciation characterized the six currencies composing the Dollar Index. However, the Real did not accompany this movement; in 2020 and 2021 it continued to depreciate, by around 35% compared to January 1st, 2020. The reason for this contrary behavior was the exaggerated decline of the interest rate in Brazil.

Before any inkling of the pandemic, in the last four meetings of the COPOM in 2019, the Central Bank cut the SELIC rate by 200 basis points, reaching 4.5%, and these cuts continued without interruption in 2020, until reaching 2% at the end of the cycle. Only from the start of 2022 has the Real followed the movements of the Dollar Index and the other currencies shown in the graph.

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