Brazil Getting Serious about BRL

Brazilian officials are getting more serious about curbing the real's strength. First, the central bank appears to have stepped up the amount of intervention and has been conducted two auctions a day to buy dollars since Sept 8. Local contacts estimate intervention to have run $1 bln a day for most of the last week. To put that in perspective, in the Jan-Aug period, the central bank appears to have bought about $18.6 bln. That compares to $7.3 in the same period last year.

Second, finance officials have threatened to intervene in the futures market-reverse currency swaps--. These were last conducted in May last year. Third, Finance Minister Mantega yesterday authorized the sovereign wealth fund to buy dollars.

Given the widening interest rate differential between the US and Brazil, the cost of intervention is becoming more expensive. Brazil issues bonds to finance its fx purchases. This is contributing to its growing budget deficit, which reached an 8-month high in July. At the same time, growth differentials and strong currency is contributing to the yawning current account deficit, which is approaching record levels.

In addition to official words and deeds, the other factor that may be working to dampen demand for the real is concern about the share sale of the Petrobras. It is preparing for a BRL78 bln share offering. However, given its investment plans, many observers expect the oil company to have to tap the bond market too. This is appears to be weighing on PBR bonds more so than share prices.

The BRL weakened yesterday and remains pinned near those lows today. Initial resistance for the US dollar is seen near BRL1.7350. A break could spur another 1% advance. It is not that we are so bearish the BRL, though we think that investors may find more attractive levels to enter/add on, but we think that it may under perform in the period ahead.