Brazil markets on forex intervention alert as real slide accelerates

By Jamie McGeever and Jose Gomes Neto

BRASILIA/SAO PAULO (Reuters) - The rapid acceleration of the Brazilian real's slide against the dollar this week has put traders on high alert for intervention from the central bank to stop the rot, although so far there is no sign the central bank has shown its hand.

With messy politics slowing the government's fiscal reform agenda in Congress, the domestic economy deteriorating and global trade war tensions rising, the real has plunged through 4.00 per dollar to its lowest level since September.

It has depreciated 3.5% this week, one of its biggest weekly declines since Brazil emerged from a brutal recession in late 2016.

A spokesman for the central bank declined to comment.

The last time the central bank intervened in the spot foreign exchange market was February 2009. Its interventions since then have been in the FX swaps market where it is routinely active, by adjusting the size and maturity of contracts it rolls over.

Market participants say it is inconceivable that policymakers will not be more sensitive than ever to the real's price, liquidity and volatility.

"It's a perfect storm for a speculative attack on the real. They (policymakers) will definitely be monitoring this," said a broker in Sao Paulo. "What the market is looking for is the point at which the central bank gets uncomfortable."

Analysts at Citi reckon that point could be soon. They point to the scale of the real's depreciation in the lead up to three previous episodes of heavy central bank activity in the FX swaps market around June 2013, May 2017 and May 2018.

They note that the central bank's first steps were taken after the real had depreciated by between 9% and 16% (or an average of 12%), and had underperformed a broad index of emerging market currencies by 8%-10%.

Now, the real is down 11% since early February and has underperformed emerging currencies by 7%, Citi's analysts say.

"We may be close to the intervention zone," they said in a note to clients on Friday, adding that a dollar spike to 4.10 reais could trigger intervention and that a rise to 4.20 would. That first threshold was breached only hours after the note was published on Friday.

"Intervention risk has clearly risen. (But) we would note that intervention has not always put an end to the sell-off," they said.

The dollar on Friday rose as high as 4.1125, the highest since September last year, and interest rate futures contracts jumped, particularly contracts a year or more out.

Despite the sluggish economy and rising risk of recession calling for lower interest rates, according to a number of economists, the rates market is now discounting 50 basis points of rate hikes to 7.00% by the end of next year.

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(Graphic: Dollar/Real - spot market - https://tmsnrt.rs/2WbgeLQ)

(Graphic: Dollar/Real - weekly change - https://tmsnrt.rs/2WcvmZn)

In a wide-ranging question-and-answer session with lawmakers on Thursday, central bank president Roberto Campos Neto said the central bank does not have an exchange rate target and believes in flexible currencies. Therefore, there is no need for the bank to have a special committee for FX intervention.

Brazil has almost $400 billion of international reserves, so the central bank has the ammunition to defend the real through selling dollars if it wanted to.

When the dollar rose to 4.00 reais in late March the central bank beefed up its presence in FX swaps market to inject liquidity into the market and ease the selling pressure on the real. The central bank was keen to stress, however, that this was not an act of intervention.

Yet volatility then was higher than it is now. Implied volatility on one-week dollar/real options contracts reached 19%, and despite rising this week, it is only just above 14% now. To compare, when the central bank intervened heavily around May 2017, one-week implied volatility soared above 30%.

So while the real's slide on the spot market move has been eye-catching, market volatility has been relatively well contained, suggesting the market is still functioning smoothly.

This will likely be a relief to the central bank, said Luciano Rostagno, chief strategist for Mizuho do Brasil, adding that a "one week move" is not enough to trigger intervention.