Every now and again Brazil’s economy stumbles and falls. This is often helped along with inept political leadership, sometimes from the left, sometimes from the right.
Forex traders have been riding the Brazilian Real down since it began to break south in January. It has been part of a weakening emerging market momentum play that, despite some short term reverses, has crashed through some significant floors against the USD.
Brazilian real dropped as USD rallied strongly in Q1
Some of this can be laid at the door of the current president, former army captain Jair Bolsonaro. Since taking power less than two years ago, he has proved to be both a combative and controversial leader for Brazilians. Despite all this he was keeping the currency in a conservative trading range at between 4.277 and 3.962 against the dollar.
The BRL was largely rangebound until we got into the New Year. Bolsonaro at that point seems to have dismissed the seriousness of the coronavirus pandemic and squabbled with governors over lockdowns (sound familiar?) He backed anti-quarantine protests and fired the health minister.
However, benchmark the BRL against most other emerging markets currencies and you can see a similar plunge. The ZAR broke through the 15.3 level versus the USD round about the same time that the BRL did and has seen similar losses, falling to within sight of the 19 level (South African rand was trading at 18.67 vs the USD at the time of writing).
We’ve now seen Bolsonaro’s approval ratings spiralling downwards like the currency, and we don’t think they will be back up anytime soon as Brazil starts to feel the squeeze of the pandemic. On top of this, corruption has reared its ugly head again in Brazilian politics with the resignation of Justice Minister and anti-corruption czar Sergio Moro.
Moro claimed that Bolsonaro was obstructing a federal investigation of whether his sons had taken part in kickback schemes and fake news rackets. Moro, it should be remembered, is the highly popular captain of the five year ‘Car Wash’ graft investigation which has brought down literally hundreds of Brazil’s top business people. The whole affair is damaging Bolsonaro’s credibility.
This does not mean that Bolsonaro is about to fall on his sword – lawmakers are not keen to begin Brazil’s second impeachment trial in four years. He also enjoys considerable popular support with a strong, right wing base. Unlike President Trump, he does not face the polls for more than two years.
Emerging markets momentum trade
But then there’s the BRL. It has been a huge momentum trade with only a couple of small retracements around 23-27 March and 3-9 April. Traders saw a sharper one 27-29 April, but it has been business as usual as we go into May. The big question is how long it will continue to fall. It is a phenomenon being shared by other emerging markets currencies.
There has been a general weakness in emerging markets currencies against the USD which has been on an impressive run. We’ve seen some profit taking in the BRL as traders have called the end of the trend, only to see it get weaker against the USD.
BRL is well outside its previous five year lows against USD which can largely be attributed to the impact of the COVID-19 outbreak. It should really be at around the 4.4 level but we are living in a very risk off environment. Most EM currencies seem to be behaving the same way.
Watch the USD, not the BRL
Going into April we have seen some shorter rallies, mainly as some USD selling has occurred. It looks as if the USD is running out of steam. BRL hit around 5.73 on 24 April and has not been there since. Instead we have seen a rally to 5.32. Similar moves occurred in the ZAR.
Right now the BRL wants to stay away from the 5.6 level and it is difficult to see how the political and economic situation in Brazil is going to have much impact when we are seeing so much volatility in the major forex markets. There may be more negative news flow out of Brazil, but the Real seems to be more responsive to some of the big moves in the dollar than anything Bolsonaro says.