UPDATE 1-Real drops for 6th day as Brazil struggles to halt FX rout

Mon Aug 19, 2013 7:37pm EDT

* Brazilian currency falls 0.9 percent to 2.4152 per dollar
    * Investors bet on more aggressive rate hikes to curb
inflation
    * Central bank chief warns against one-way bets on the
currency
    * Treasury says working with central bank to stabilize
market


    By Walter Brandimarte and Luciana Otoni
    RIO DE JANEIRO/BRASILIA, Aug 19 (Reuters) - Brazil's real
weakened for a sixth straight session on Monday even as the
central bank and the Treasury joined forces to stem a rout in
currency and bond markets that has added to inflation fears in
Latin America's largest economy.
    Worried that policymakers may have to step up their monetary
tightening campaign against inflation, investors pushed
interest-rate futures sharply higher while dumping
locally-issued government bonds. (See table below)
    As a result, Brazil's domestic yield curve now shows a 50
percent chance that the benchmark Selic rate may rise by 75
basis points next week, and not the half percentage point most
economists had forecast. 
    While most emerging market currencies have been affected by
fears of an expected withdrawal of U.S. stimulus measures,
Brazil has been specially hard-hit as its slow-growing economy
has fallen out of favor with investors. 
    After a series of government interventions designed to prop
up the economy, many of which have backfired, Brazil's economy
is now expected to grow only 2.2 percent this year and 2.5
percent in 2014, according to the average estimate of private
economists.
    While a government source told Reuters on Monday that a
persistently weak economy will help keep inflation in check,
central bank chief Alexandre Tombini suggested bets on a more
aggressive monetary tightening are exaggerated. 
    "The recently observed moves in interest rate markets
incorporate excessive premium," he said in a statement.
    Tombini also tried to soothe markets by reassuring that the
central bank will keep offering protection against currency
volatility and warned investors against one-way bets on the
real, saying they could incur "losses."      
    Tombini's comments came only after markets had closed,
however, too late to stop the real  from closing at
its weakest level since March 2009. The Brazilian currency slid
0.9 percent to 2.4152 per dollar, adding to last week's losses
of more than 5 percent.
    "The next resistance level is around 2.5 per dollar," said
Caio Sasaki, an analyst with XP Investimentos in Sao Paulo. "The
sell-off is due to investors' skepticism about our fundamentals.
There are better (investment) opportunities coming in the United
States."
    Citi strategists said some analysts already expect the real
to weaken to between 2.50 and 2.70 per dollar through the end of
the year.
    "The horizon is still cloudy (for the real), with the fiscal
and economic situation remaining the same," they wrote in a note
to clients on Monday.
    
    COORDINATED ACTION    
    The real continued to slide even after the central bank sold
about $3.5 billion worth of traditional currency swaps in three
separate auctions and announced it will sell on Tuesday as much
as $4 billion on the spot market through repurchase agreements.
    Swaps are derivatives sold by the central bank in the
futures market to provide investors with protection against a
further depreciation of the real. They are part of a government
strategy to ease demand for dollars without burning the
country's $370 billion in foreign reserves.
    Still, many analysts say that strategy has run its course as
companies are unwilling to hedge again currency risk at current
exchange rate levels. Instead, they say, demand is growing for
dollars on the spot market.
    With Tuesday's auction of spot dollars, the central bank
will try to satisfy that demand without using its foreign
reserves, since the greenbacks will return to the bank's coffers
on Jan. 2 and April 1. 
    While the central bank tried to stabilize the foreign
exchange market, the Treasury conducted an unplanned auction to
buy and sell fixed-rate notes that have also been suffering 
from the increased volatility in Brazilian financial markets.
    "We have seen very high volatility over the past three days,
with traders demanding very high returns for Brazilian bonds in
the secondary market as the real weakened," a second government
source said.
    Another government source said the Treasury will make as
many extraordinary auctions as needed to stabilize the country's
secondary debt market.
    The Treasury and the central bank are working in a
coordinated fashion to reduce volatility in the currency and the
interest-rate markets, the previous source said.
    
    Most-traded interest rate DI contracts at close:
    
 Month  Ticker      Last(pc     Previous       Change
                      t)       Close(pct)      (p.p.)
 OCT3                8.692       8.666          0.026
 JAN4                9.33         9.2           0.13
 JAN5                10.66       10.33          0.33
 JAN6                11.53       11.18          0.35
 JAN7                11.84       11.61          0.23
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