FX Intervention to Stabilize or Manipulate the Exchange Rate? Inference from Profitability

IMF Working Papers, June 12, 2020

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Swaps used by the central bank of Brazil are profitable in expectation, implying that FX intervention is used to stabilize the exchange rate in the face of temporary excessive movements rather than to manipulate it away from fundamental values.
The scale of FX intervention responds to the degree of exchange rate misalignment relative to UIP conditions.
Intervention is more aggressive when there is less uncertainty about the medium-term level of the exchange rate.
Intervention is more aggressive when the exchange rate is overvalued rather than undervalued.

Analysis centers on the profitability of FX swaps (currency swaps) deployed by the central bank of Brazil.
Empirical inference links expected swap returns to the underlying rationale for intervention (stabilization versus manipulation).
Examination of responses of intervention intensity to:
- Exchange rate misalignment relative to uncovered interest parity (UIP) conditions.
- Measures of uncertainty about the medium-term exchange rate level.
- Direction of misalignment (overvaluation versus undervaluation).

Subject: Currency swaps, Exchange rate forecasting, Exchange rates, Financial services, Foreign exchange, Interest rate parity
Keywords: core swap action, Currency swaps, exchange rate, Exchange rate forecasting, exchange rate movement, Exchange rates, expected return, FX intervention, FX intervention in Brazil, FX reserve, FX swap, Interest rate parity, long position, profitability, swap auction, swap profitability, swap return, swap sale, WP