This is ironic, Brazil.
That’s a Nomura chart showing the Brazilian government as the biggest ‘loser’ of the currency war. You know the war we’re talking about: Brazil was the first and loudest to declare it in 2010. Oops.
As Nomura remind, that war’s been about emerging markets trying to prevent capital inflows from putting a rocket under a) inflation b) their currencies, now that US quantitative easing has restarted a worldwide hunt for yield. It’s taken central bank policies to an odd, ‘post-modern’ place compared to the traditional tools they use.
The problem that we can now thank Brazil for discovering is that it’s become difficult to manage a) and b) simultaneously, especially with generally surging commodity prices worldwide.
The chart above brings together changes in inflation before and after quantitative easing was signalled, changes in inflation forecasts, both nominal and real exchange rate changes, and changes in central bank policy rate forecasts and one-year swap rates. Nomura FX strategist Tony Volpon puts it best as to why Brazil loses across the board here (emphasis ours):
Why does Brazil stand out as the biggest loser? The attempt to hold back nominal appreciation of BRL through capital controls (the IOF tax) has proven to be ultimately unsuccessful because of changing policy emphasis over time. By holding back BRL, the inflation pass-through of higher commodity, especially food, prices has been large, leading to an appreciation of the real exchange rate. Now faced with higher inflation, the BCB is signaling that it will likely hike interest rates this month, which has led to another round of nominal appreciation, undoing the effect of the IOF tax on the exchange rate. By apparently switching policy imperatives from the level of the exchange rate back to lower inflation Brazil has ended with a mix of an appreciated currency alongside higher inflation and interest rates. By changing emphasis, Brazil is ending up losing on both counts.
The perils of post-modernism. Inconsistent post-modernism, that is.
There are more consistent central banks out there. Turkish ten-year bond yields plumbed a record low on Wednesday after officials there signalled commitment to cutting rates (and thus, carry). On the other hand, Poland has got off the bus and signalled consistent rate hikes. In both cases you could argue that currencies are the main focus for now.
Brazil’s fate doesn’t really look good for emerging markets in 2011.
We argued once that Brazil could be seen as a fairly clever currency warrior in terms of using capital controls as a cover for managing its government debt more effectively. Mexico took advantage too, at the time.
That was when emerging markets had the luxury of investors chasing yield irrespective of whatever inflation or tightening is in prospect.
Well, compared to Brazil’s wider policy problem now — not any more.
Related links:
Bernanke’s genie released - FT Alphaville
Global food prices hit record high – FT
Indonesia holds rates amid inflation fears – FT