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Foreign Exchange

Brazil policy U-turn materially improves BRL outlook; currency war truce called

New-found government resolve in Brazil to avoid additional BRL weakness has materially improved the currency’s outlook, according to a strategist at ING.

Gustavo Rangel says recent government decisions suggest it has finally dawned on Brazilian policymakers that excessive vigilance on its FX policy has backfired, triggering what it fears most: deterioration in investor confidence about growth in the country. Indeed, rising concerns about Brazil – fuelled by a combination of excessive FX volatility and weakening economic data – threatens a fierce cycle of dwindling investor appetite for Brazilian assets, adding downside to foreign direct investment and still much-needed external financing, he says.

The pushback against BRL weakness started with the central bank, which shifted its stance in early May after USDBRL moved up through R$1.90.

The government took longer, but followed suit last week.

Guido Mantega, the country’s finance minister – who had previously railed against BRL strength and coined the term “currency war” in response to what he saw as irresponsible monetary easing in the world’s main economies – started dismantling the curbs the country had put in place during the past couple of years to keep what it termed “speculative” funds offshore.

Rangel does not underestimate the symbolic importance of Mantega’s announcement and what it suggests about government preferences as far as USDBRL is concerned.

“This new-found government resolve to avoid additional BRL weakness materially improved the currency’s outlook,” he says.

“And given the large arsenal of FX curbs that are still in place and that could still be phased out, we expect the BRL to outperform other EM currencies, particularly in a risk-off environment.”

 Brazil FX flows turned more favourable in June

 
 Source: BACEN

Rangel notes that FX flows have also turned more favourable in June, according to partial data for the month. Financial flows in particular have turned to a surplus, after three consecutive months of net outflows.

While it is still too soon to say whether last week’s announcement will do much to change investor sentiment, this data is suggestive of a more-constructive underlying FX trend, he says.

ING recommends long BRLCLP positions for investors willing to take a constructive view on BRL.

Apart from the new-found decision from Brazil to fight weakness in its currency, ING believes the negative external trade dynamics in Chile should also act to partially reverse the CLP’s sharp gains relative to the BRL since early March.

Chile’s trade surplus is dropping faster than expected, having reached $3.7 billion so far this year against $7.3 billion in the same period last year. According to Chile’s central bank, this will help trigger a sizeable rise in the country’s current-account deficit from 1.3% of GDP in 2011 to 3.1% in 2012.

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