The Long View - Independent Views on Brazilian Economy and FX Market

One week to go before the US lowers interest rates, and Brazil may raise rates - consensus is for a 0,25% move in each direction. Even though this could create a 5.75% differential between the two countries respective interest rates, there is no?sign of a move up in the BRL vs the USD. While we wait to see not only next weeks decision, but also the language and tone behind the decision i.e. are there deeper cuts ahead, is there a looming US recession, or just a slowdown?Brazil, on the other hand is concerned about rising inflation, and a lack of government?commitment to rising budget deficits and debt, hence the chance of a rate hike.

So, what do you do? Historically speaking, it is fair to assume?that there will be a period of strength over the next few weeks/months. Even when the pandemic was in full swing, there was still a?period which saw USD/BRL go from 5.84 to 4.95 - a huge move. Over the last five years the average time period of BRL strength to weakness is between 4-5 months, there subsequently follows a period of intermittent strength, although shorter in duration - average 2 - 3 months - but with some periods only lasting a couple of weeks. The?challenge today?is that the headwinds in Brazil outweigh the tailwinds, so should a moment of BRL strength ensue, the temptation to re-dollarize yourself will be difficult to resist.

The Economist recently wrote?an article on 'How to halt Brazil's decline', and while there was nothing really thought provoking about the article there was?something that?resonated?- Managed Decline. According to the IMF, Brazil currently has an 86.7% government debt to GDP ratio,?(click link) set to rise to close to 100% by 2029. Whether or not this materializes is not yet?important, what is however, is the perception that the current path of over spending and over taxing will ultimately lead to higher inflation and a stagnant economy. While this remains a constant, any periods of BRL strength should be viewed as temporary.That does not mean that things cannot change, as the point of this brief is to suggest an outline of what can happen, not what will happen, clearly, trajectories can be altered?and the direction of travel can be less volatile. Things in Brazil can change on a dime, but the issue is that right now there is very little?suggesting?that it will. If Lula is planning another re-election campaign (I can hear the sighs) then it won't be austerity that gets him re-elected.

As the world is fragmenting into blocks and regions of power, the choice of trading partners becomes?important, and Brazil still can play that game well (be friends with everybody), however poor infrastructure,?inconsistencies within legal rulings and corruption, are only a?few of the reasons of that may?deter foreign capital, or at least make investors?think twice. Brazil is a regional power in a region that is relatively isolated and unimportant geopolitically - that can be good - but it means that you need to work extra hard to attract investment and this is not the case right now.

The abundance of natural resources mean that capital will always flow, but it is?short term trade capital, not long term investment or infrastructure capital. The currency is being stubborn, refusing to move up vs the USD, but it can, and may?well rally into year end, but for how long remains impossible to know. If you are an individual, or business that is looking to convert BRL into USD you should use any opportunity of relative strength. Do not make the mistake of thinking that it will get stronger the longer you wait. If you live and work in Brazil you earn?in reais, so you are a natural accumulator of the local currency. If the BRL surprises, and strengthens for longer?than people expect, then you probably will have saved enough currency to take advantage again.