Forex Flash: BRL Pendulum swings again – BBH

Share | (Barcelona) - Iian Solot, Emerging Markets Strategist at Brown Brothers Harriman believes that expectations for the Brazilian real have swung again.

Now, the skew of observers is moving towards those who think that a break below the USD/BRL 2.00 level is more likely than a break above 2.10. He is sticking to his view that the 2.00 level will hold for now, but he feels that the pair could undershoot a bit before the government steps in, akin to the overshooting change in thinking within the administration. He notes that any interpretation of Brazil´s opaque economic policy making has a short shelf line and should be taken with a grain of salt.

Solot notes that the level shift in USD/BRL to above 2.00 was driven bythe view that Brazil can achieve a policy mix of ( A ) lower interest rates, ( B ) weaker currency, ( C ) Currency/Capital Controls, ( D ) tame inflation, and ( E ) solid growth (originally forecasted at 4% for 2012. He calls this the "have your cake and eat it" part of the debate, personified by Finance Minister Mantega and other ´Developmentalists´ - PM Dilma included. He writes, "So, whatever happens, this view will continue to determine the broad ideological outline of the current administration´s macroeconomic policy.

However, he writes, "Mantega's views appear to be losing ground to another line of thinking. Let us call it the "somethings got to give" view. We presume this view is being advanced by a group of economists at the helm of the central bank, including President Tombini. It anticipates that, at the very least, the assumption on inflation is unlikely to hold under these conditions. This view gains even more traction in the context of the deteriorating fiscal deficit due to greater spending and the recent negative developments in the energy sector, as the lack of rain and proper infrastructure planning may force a switch from hydro towards more expensive thermo energy. In addition, this camp could also be advocating the need to be nicer to financial markets if the government wants to realize its investment goals and not embarrass itself in the upcoming Would Cup and Olympics."

The evidence that the second camp has the upper hand (for now) is twofold notes Solot. First, heavy artillery was used by both the Finance Ministry and the central bank to defend BRL as it moved above 2.10. Second, recent commentary points in this direction, in particular the much discussed interview by Mantega late last week in which he stated that 2013 will be a "calmer year, and with less measures."

With everything said, Solot still assumes that this change in direction was more of a reluctant compromise, or a truce, rather than a deep ideological sea change. He writes, "Therefore we doubt they will be willing to give so much ground as to let the 2.00 level go - if nothing else, as a matter of pride. We think USD/BRL is still stuck between 2.00-2.10 and promises a relatively low realized volatility going forward. As such, we still think long BRL positions with a view towards carry offer a good risk reward for medium-term investors. 1-month BRL implied yields are currently near 5%, which remains above CLP, COP, and MXN (all clustered near 4%). With much of EM still cutting rates in 2013, the real's yield advantage is likely to get even bigger since nominal rates have likely bottomed in Brazil."

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

This article appears in: Investing , Forex and Currencies

Referenced Stocks: A , B , C , D , E

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As of 4/22/2014, 04:07 PM