U R in Trouble: Brazilian Forex Intervention

♠ Posted by Emmanuel in , at 8/23/2013 10:03:00 AM
 Here's another victim of the so-called "taper" of Federal Reserve purchases of US Treasuries worth $85 billion a month or so. To make a long story short, rising interest rates Stateside in expectation of less American bond market intervention from the Fed are causing those who've invested abroad in search of higher yields to reassess their strategies. For several years there was a Brazil "carry trade": borrow in dollars, convert to Brazilian real, then lend in real while pocketing the interest rate spread (after charges and fees, of course). 

The end of Fed Treasury purchases has whiplashed many developing countries like Brazil. Not only are their economies slowing down as China does and demand for raw materials dwindles accordingly, but the carry trade becoming less profitable also has negative repercussions for their currencies. Brazil, already encountering an economic slowdown--remember those protests and riots a few weeks back--is simultaneously trying to combat higher inflation. The latter cause will not fare especially well as the real continues its slide.

So, faced with few alternatives, it's back to the time-tested solution: currency intervention...
Brazil's central bank announced a currency-intervention program on Thursday that will provide $60 billion worth of cash and insurance to the foreign-exchange market by year-end, a move aimed at bolstering the country's currency, the real, as it slips to near five-year lows against the dollar.

The bank said in a statement it will sell, on Mondays through Thursdays, $500 million worth of currency swaps, derivative contracts designed to provide investors with insurance against a weaker real. On Fridays, it will offer $1 billion on the spot market through repurchase agreements. Both are designed to prevent companies and individuals with dollar obligations from scrambling to the market at the same time, afraid that waiting will force them to pay more to buy dollars. When that happens, the real tends to weaken further and faster.
What Brazil is essentially trying to do is ensure that not everyone heads for the (Brazilian real) exit at the same time. Still, you have to wonder if this kind of "demand management" is enough to stop the real's slide. At any rate, the irony is not lost here: As the United States winds down its market intervention (Fed Treasury buying),  other countries like Brazil must step up their market intervention (through FX intervention and the like).