Understanding the behavior of the dollar: Clash of trends

Since the end of May, the exchange rate in Peru has been showing an upward trend. In those days it was close to S/3.65, while today it is closer to S/3.80. However, this occurs in a context where we identify two main trends, which we comment on below.

In the first place, we have upward pressure sustained by a growing expectation of increases in international interest rates, particularly in Dollars Americans. This is directly related to the inflationary pressures that are being observed around the world, especially in the United States. Why? Because inflationary processes are usually faced with a rise in interest rates. The reasoning, in a simplified way, is that raising interest rates makes access to credit more expensive in the economy, cooling economic growth and consumption. In this way, since it is more difficult to sell the same quantities, no one will think of raising the prices of products or services that are more difficult to market.

At the same time, the expectation of higher interest rates also generates an effect that makes investments and/or placements in Dollars Americans, because they yield or will yield a higher profitability. This is, finally, what directly influences the supply and demand for Dollarswhich ends up deciding the price of the dollar. As there is an expectation of higher returns on positions in Dollars, the demand for said currency increases to the detriment of the positions in Soles. For this reason, we mention that there is upward pressure on the exchange rate.

On the other hand, there are also factors that put downward pressure on the value of the exchange rate locally. The Central Bank of Peru is trying to compensate for what we mentioned in the previous paragraph through increases in interest rates in Soles. The agency recently decided to raise its reference interest rate again, taking it to 5.50% per year, when a year ago it was at levels of less than 1% per year. We believe that this also has a significant effect on the value of the dollarwhich has considerably softened the rise in the exchange rate, making positions in local currency more attractive.

At the same time, there is a background trend in the market, evidenced since the beginning of December last year, where the market has finally incorporated into prices the little or no probability of structural changes in the Peruvian economy by the Government. During most of 2021, attempts were being made to install a near-apocalyptic message in the country regarding the fate of Peru’s economy and the intentions of the new government once it came to power. For its part, from the first moment and in all these months, the Government has tried to ward off these ghosts both from the speech, but also from the facts. We understand that as of last December, the market has been convinced that, at least from the economic point of view, the probability of structural changes in the economy is very low, which took away the support of a dollar above S/4, taking it even to pre-election levels at the beginning of last year.

The constant clash of both trends is what keeps the exchange rate relatively calm, without large variations or a defined trend. We believe that it will be necessary to closely monitor the evolution of the factors mentioned above to assess the trend that the price of the dollar in the Peruvian economy in the coming months. The evolution of factors that aggravate world inflation such as the war in Ukraine, such as the bottlenecks in the production and supply of certain raw materials or key inputs in the production process, is something that we must follow closely. As well as the actions that the Central Banks are taking to combat it.