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The usual impression is that the exhaustive situation one can find when you look at the latest development of the BRL. For some time USDBRL remained below the psychological level of 4.00, despite the political chaos of the new government, despite the external uncertainties due to the trade conflict between China and the USA and despite the rather moderate growth prospects for the Brazilian economy. The intensification of the trade conflict and further disappointing economic data from Brazil seem to have been the last straw: last week USDBRL climbed above the 4 marks.
However, we remain cautiously optimistic and expect a firmer BRL in the course of the year – provided the pension reform is passed successfully. We hold onto OW BRL, which should continue to benefit from Congress progressing on passing the social security reform. In C. Carranza, we estimate that BRL could reach 3.55/USD if foreign BRL hedge positions were unwound to $15bn from $30bn, average levels during 2017, based on a regression on large (>2%) changes. These results are very similar to the previous analysis back in October after the electoral rally when BRL was close to 3.70. Whereas the increasing probability of BCB rate cuts could lower FX-hedging costs further, the compression in long-end yields has made FX-hedging bond exposures relatively unattractive in our view. Separately, we note that our JPMorgan EM Client Survey shows a score of +2.6 for BRL, increasing by +0.7 since last month and therefore indicating that BRL exposure has indeed moved higher, although accounts still have space to add risk in our view.
Admittedly, many market participants have turned more constructive as well in the past month, particularly as Speaker of the House Rodrigo Maia suggests that the Lower House would be able to pass reform in two key votes this week, while the PSL (the President’s party) would refrain from proposing additional amendments to the reform to expedite the process. Positioning still points to large FX- hedged positions though according to BMF data, and we, therefore, find FX more attractive than bonds at current levels.
Nevertheless, the positive ripple effects of the passing of the reform should still be BRL-supportive. Namely, fewer fiscal concerns could reverse the negative investor sentiment that caused four years of bond outflows, particularly as rating agencies have expressed their view that the passing of the Pension reform could be credit positive. Courtesy: JPM
