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P 261758Z MAY 06
FM AMEMBASSY BRASILIA
TO RUEHC/SECSTATE WASHDC PRIORITY 5472
INFO RUEATRS/DEPT OF TREASURY WASHINGTON DC PRIORITY
RUEHRG/AMCONSUL RECIFE 4827
RUEHSO/AMCONSUL SAO PAULO 7022
RUEHRI/AMCONSUL RIO DE JANEIRO 2130
RUEHBU/AMEMBASSY BUENOS AIRES 4028
RUEHSG/AMEMBASSY SANTIAGO 5519
RUEHAC/AMEMBASSY ASUNCION 5443
RUEHMN/AMEMBASSY MONTEVIDEO 6258
RUEHME/AMEMBASSY MEXICO 1973
RUEHCV/AMEMBASSY CARACAS 3253
RUEHBO/AMEMBASSY BOGOTA 3754
RUEHQT/AMEMBASSY QUITO 1826
RUEHLP/AMEMBASSY LA PAZ 4596
RUEHPE/AMEMBASSY LIMA 2997
RUEHC/USDOC WASHDC
RHEHNSC/NSC WASHDC

C O N F I D E N T I A L SECTION 01 OF 02 BRASILIA 001016 
 
SIPDIS 
 
SIPDIS 
 
NSC FOR CRONIN 
TREASURY FOR OASIA - DAS LEE, DDOUGLAS 
STATE PASS TO FED BOARD OF GOVERNORS FOR ROBITAILLE 
USDOC FOR 4332/ITA/MAC/WH/OLAC/JANDERSEN/ADRISCOLL/MWAR D 
USDOC FOR 3134/ITA/USCS/OIO/WH/RD/SHUPKA 
STATE PASS USAID FOR LAC 
 
E.O. DECL:05/25/2016 
TAGS: EFIN ECON PGOV PREL BR
SUBJECT: BRAZIL - SPECULATION ABOUT SPECULATIVE CURRENCY ATTACK 
 
REF: A) BRASILIA 1008   B) BRASILIA 0961 
 
Classified by Economic Counselor Bruce Williamson, reasons 1.4 
(b) and (d). 
 
¶1. (U) Local financial press reported on May 25 that the Real's 
4.5% depreciation of the previous day had been the product of a 
speculative attack by foreign hedge funds.  According to leading 
financial daily Valor Economico and influential economic 
journalist Miriam Leitao, foreign hedge funds that were trying 
to sell inflation-indexed real-denominated GoB bonds (maturing 
in 2035) discovered that, due to the current financial market 
volatility and emerging market risk reassessment, the secondary 
market for the long bond had completely dried up.  According to 
these reports, the funds then led a speculative attack on the 
Real until the GoB stepped in to calm the markets by 
re-purchasing its long bonds.  In another setback, after finding 
no market for its fixed-rate longer term domestic debt, the GoB 
was compelled to issue shorter term variable-rate bonds indexed 
to the overnight benchmark rate (SELIC) in order to meet its 
financing requirements. 
 
¶2. (C) JP Morgan Brazil President Charles Wortman and CSFB Chief 
Economist Nilson Teixeira told Econoff May 25 that they were 
puzzled by the media's characterization of the events of May 24, 
which they did not believe amounted to a speculative attack. 
Wortman, many of whose clients have been steadily moving out of 
Real-denominated assets over the course of the last week, said 
that there did not appear to have been a coordinated action 
against the currency.  He argued that it made little sense for 
the hedge funds, if their motivation was displeasure over their 
inability to unload GoB Real-denominated bonds, to attack the 
currency as this would further undermine the value of their 
assets.  Moreover, he noted, most of the depreciation had taken 
place late in the trading session, when a lack of liquidity 
meant smaller transactions could have larger effects on the 
price.  Separately, Teixeira stated that he did not believe the 
depreciation of May 24 had been caused by a speculative attack. 
 
¶3. (C) Both Wortman and Teixeira stated that Brazil's 
fundamentals remained solid.  Teixeira said these fundamentals 
would reassert themselves after world financial markets adjusted 
to new risk perceptions and reached a new equilibrium.  Wortman 
elaborated on this point:  Brazil's private sector was much less 
indebted now than during the 1998/99 Russia financial crisis or 
the 2002 crisis of confidence over Lula's likely election.  The 
country's foreign currency debt, moreover, has declined and its 
tenor has increased.  The public sector has no net foreign 
currency exposure right now, he added, given its US$63 billion 
in reserves, reduced external debt and elimination of 
dollar-linked domestic debt. 
 
¶4. (C) Despite the volatility and high net dollar outflows in 
the seven days leading up to May 24, Wortman stated that JP 
Morgan is still seeing investor interest in Brazil remain 
strong.  The company had just sponsored a group of investors on 
a two-week visit to Brazil that happened to coincide with the 
outbreak of market volatility.  These investors, according to 
Wortman, remained very interested in Real assets despite the 
episode and were planning to invest.  Wortman interpreted this 
to mean that, despite the global asset reallocation that major 
institutional players were undertaking, Brazil remained a good 
bet.  He further noted that market volatility in Brazil tends to 
be higher in environments like this one in part because it is a 
more liquid market than most emerging economies.  This means 
institutions that are reducing their exposure to the emerging 
market asset class find it easier to move out of Brazilian 
assets than those of other countries.  The volatility, 
therefore, is not necessarily a good guide to the market's 
 
BRASILIA 00001016  002 OF 002 
 
 
perceptions of Brazil's fundamentals, Wortman argued. 
 
¶5. (C) Comment:  Financial market actors here seem to be fairly 
confident that Brazil's solid economic fundamentals should 
reassert themselves once the international markets have 
re-balanced.  If overly prolonged, however, the current market 
uncertainty could begin to undermine some of the GoB's recent 
achievements, including its move away from issuance of variable 
rate domestic debt linked to the SELIC, which it was replacing 
with fixed rate and inflation-indexed long-term domestic debt. 
(Note: the GoB does have a large cash reserve to cover upcoming 
debt repayment obligations, but would prefer not to draw on it.) 
 If continued, the market volatility may also slow, or perhaps 
even interrupt, the Central Bank's current cycle of monetary 
loosening.  But as Finance Minister Mantega's barely-concealed 
glee during a May 25 interview made clear, there are many here, 
particularly among exporters, who welcome the devaluation and 
dearly would love to see the Real continue to weaken. 
 
CHICOLA