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Foreign Exchange

Central bank intervention: Brazil fires currency bazooka at speculators

Concerted intervention curbs appreciation; Interest rate differentials counteracted by IOF

Hank Paulson first brought the bazooka metaphor to the public’s attention at the nadir of the banking crisis in 2008, but the Brazilian Central Bank has been applying it in its currency war with speculators.

Since September the BCB has begun twice-daily currency auctions, sometimes holding three in a day; has trebled its tax on foreign investment in Brazilian fixed-income securities; set reserve requirements at 60% on short-dollar positions held by local banks; and reintroduced reverse currency swaps to effectively buy dollars in the currency futures market for the first time since May 2009. It has also authorized the Brazilian sovereign wealth fund, Fundo Soberano do Brasil, to trade in currency derivatives.

Diego Donadio, BNP Paribas’ Latin American FX and interest rate strategist in São Paulo, says the evidence suggests that the bazooka effect is working: "The IOF [a transactions tax] was increased to 6% in late October so the November balance of payments data was our first indication of the tax’s effectiveness,’’ he says. "The data showed that whereas net foreign investment in fixed-income assets had been between $1 billion and $1.5 billion in preceding months, in November the net figure was zero."

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