Brazilian Real Strengthens as Fed Rate Hike Bets Ease

The Brazilian real rose to 5.17 per USD from the three-month low of 5.22 on July 2nd as weak labor data from the US threatened to stretch the rate differential between the Fed and the BCB. The interest rate differential remains supportive for the real, with Brazil's benchmark Selic rate at 14.25% compared with the US policy range of 3.50%-3.75%. The wide yield gap continued to attract foreign inflows and support the Brazilian currency. Domestic gross public debt rose above forecasts in May, while primary deficit was wider than expected. The deterioration in fiscal accounts reinforced expectations of higher-for-longer borrowing costs and persistent upward pressure on interest rates. In addition, Brazil’s annual inflation rose past 4.8% in the first half of June, above the central bank's upper target band of 4.5%

The Brazilian real traded near 5.17 per USD in June, strengthening slightly toward the end of the month amid a broader pullback in the US dollar. Softer-than-expected US PCE data eased concerns over additional Federal Reserve tightening, pushing Treasury yields lower and weighing on the dollar against major and emerging market currencies. In Brazil, the BCB’s updated Monetary Policy Report raised the probability of inflation breaching the upper bound of the target range, despite June’s softer-than-expected mid-month inflation reading. Still, the interest rate differential remained supportive for the real, with Brazil’s benchmark Selic at 14.25% compared with the US policy range of 3.50%-3.75%. That wide spread has continued to attract foreign inflows and provide support to the Brazilian currency.

The Brazilian real weakened to around 5.19 per USD in late June, tracking broad dollar strength against nearly all major currencies. The greenback advanced against G10 and emerging market peers after hawkish projections from Federal Open Market Committee members in their latest policy decision led markets to price in more than one rate hike by the US Federal Reserve this year. In Brazil, the dollar also found support in the minutes of the latest Copom meeting, which reinforced expectations that the benchmark Selic rate may fall in the near term, even as policymakers acknowledged that upside risks to inflation still outweigh downside risks. The outlook points to a narrower interest rate differential between Brazil and the US, reducing the appeal of Brazilian carry trades and supporting further gains for the dollar.