In the last few weeks it has all gone horribly wrong for commodity-related and emerging market currencies. From their peaks in March the South African rand has fallen by -15%, the Australian dollar by -14%, the Brazilian real by -13%, the Indian rupee by -11% and the NZ dollar by -10%. A major chunk of those losses came in the last month after the Federal Reserve chairman told a congressional committee that he sees a limited future for the Fed’s programme of quantitative easing.
For 18 months the Federal Reserve has been printing $85bn a month and spending it on bonds, predominantly housing market debt. Not only has the money helped to turn the US property market from decline into growth (house prices rose by 10.9% in the year to March) it has also found its way into all sorts of investments that return a higher yield than dollar bonds and deposits. In late May the Fed chairman reminded investors what he had told them a few months ago: the bond-buying programme will be stepped down (or “tapered” to give it its catchy media handle) when the US economy is back on course. The chairman’s comment was hardly news to investors but they reacted like startled rabbits when they realised that, sooner or later, the Fed would turn off the tap and the cash would cease to flow. In theory the central bank will continue with its stimulus until it achieves an inflation rate of 2% and an unemployment rate of 6.5%. In practise, monetary policy is such a lumbering, clumsy oil-tanker of an instrument that its operators must begin to apply the brakes when the destination is still over the horizon.
The assumption is that removal of the stimulus will mean – among other things – removal of the buying pressure on higher-yielding emerging market currencies and a loss of appetite for commodities and energy as the world’s economy settles back onto a stimulus-free even keel. Hence the broad exodus from the real, the Australian dollar et al.
For Finance Minister Guido Mantega it means a reversal of the effort he put into suppressing the value of the real a couple of years back. Now he wants to support his currency, not to keep it down. Five years ago he doubled the IOF foreign exchange transaction tax to 4%, aiming to slow the inflow of funds. In summer 2011 he increased it to 6%. This June he cut the tax to zero and also removed the 1% tax on financial derivates that was intended to discourage speculative bets against the dollar. The Banco Central has been busy too, raising its benchmark interest rate by half a percentage point to 8% and intervening to support the real in the FX market. For more information on the foreign exchange market please click here.
Nevertheless, in the last month the real has weakened by 9% against the dollar and the pound. The heat is on for the real and its peer group, and it is unlikely to dissipate until either the Brazilian economy displays evidence of being able to take care of itself in bad times as well as good or the Federal Reserve issues some statement to allay investors’ fears about the end of quantitative easing. It will not be a one-way-street (currency moves seldom are) but unless the circumstances change it is likely that the real will decline further against the dollar, the pound and the euro for sending money abroad.