Bearish on Brazil's real despite recent appreciation
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Emerging Markets

Bearish on Brazil's real despite recent appreciation

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Despite the BRL's recent rise following hawkish comments from officials after bad inflation data, some strategists are bearish

The Brazilian currency appreciated 1% versus the dollar on Thursday, after data showed inflation rose in January at its fastest monthly pace in nearly 8 years, prompting some analysts to say that authorities have changed their position and now want the real to protect against inflation rather than act as a tool to boost growth.

Comments by Brazilian central bank president Alexandre Tombini, who told the O Globo newspaper that he was “concerned about inflation in the short term,” sent the currency to 1.9610 against the dollar, the highest level in 9 months according to Reuters.

On Friday, the real jumped 1% versus the dollar in the first minutes of trading but fell after the central bank bought dollars by offering reverse currency swaps in the derivatives market for the first time since October.

“The central bank will tolerate a stronger real in an effort to limit imported inflation, but this will come at the expense of a further deterioration in Brazil’s external competitiveness, which will weigh on economic growth,” Neil Shearing, chief emerging markets economist at Capital Economics, said.

But Marjorie Hernandez, a strategist with HSBC Securities, is still bearish on the BRL although she upgraded slightly the target for the currency’s exchange rate versus the US dollar to 2.15 for the end of the year from a previous forecast of 2.30.

“We do not expect the BRL to be used more actively as an inflation-fighting tool as this would require a more sizable and permanent adjustment of the FX rate, which would likely be unacceptable to the administration,” Hernandez wrote in a market note.

“Instead the main intention behind the change in the stance on FX policy appears to be containing rising inflation expectations.”

In the near term, she expects the real to trade in range between 1.95 and 2.05.

Beyond the inflationary risks for the next few months, Hernandez believes that “the bigger concern for this administration is to revive the anaemic pace of economic growth.”

“We believe that if inflation concerns recede in the second part of the year, the bias will still be for a weaker currency and thus we remain bearish on the BRL for 2013.”

INDUSTRIAL PRODUCTION DOWN

The Brazilian currency appreciated not because the fundamentals of the economy have improved but because it benefited, together with other emerging markets currencies, from the return of risk appetite following the reduction of tail risks in Europe and the US on the backdrop of excess liquidity, she argued.


Net foreign long BRL positions increased by $6 billion since the beginning of December, while short USD-BRL positions are at their lowest level since September 2011, Hernandez noted. The real also benefited from the recovery in Chinese growth, with the price of iron ore – the most important commodity export from Brazil – surging 29% since the end of November last year, she added.

Hernandez does not expect the currency to be used more actively as a tool to fight inflation because the pass-through of exchange rate changes into inflation is “not immediate” and the appreciation would need to be permanent.

Moreover, the central bank’s weekly surveys show market participants still expect inflation to recede towards 5.68% at the end of the year and the bank has said that usually, periods of depreciation in the currency tend to push inflation up faster and more intensely than periods of real appreciation reduce prices, she said.

“We interpret the change in FX policy as complementing the government’s other efforts to combat inflation with a particular emphasis on containing inflation expectations,” Hernandez said.

The weak recovery in the industrial sector is another factor that could contain the BRL’s rally, according to Eamon Aghdasi, a strategist at Societe Generale.

Industrial production fell 3.5% year-on-year in December, dragged down by a fall of 14.7% in the production of capital goods; it fell by 2.7% for the whole of 2012.

Brazil posted a record trade deficit of $4 billion in January, higher than expectations of a $3.4 billion gap in a Bloomberg survey of economists; it had a trade surplus of $2.25 billion in December.

“The problem with the notion of a stronger currency at this particular moment is that the recovery in industrial activity and exports does not seem to be taking hold,” Aghdasi said.

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