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We’ve been watching the Brazilian real (BRL) for some time now, because its decline against the USD has represented quite an attractive long term short. Brazil, as many of us will remember, was once trumpeted as the ‘B’ in the BRICS countries, those emerging markets that Goldman Sachs analysts considered would rise to dominate global economic affairs in the 21st century. It was a nice idea, but 17 years into the century and many of the BRICS countries are in difficulties, with only China so far having reached a fraction of the potential ascribed to it.

Analysts are hoping that the rise in US rates will somehow lead to a return to emerging markets assets, including those denominated in the BRL. For example, a successful airport auction this month which saw three European groups awarded the rights to operate four airports in Brazil was oversubscribed. This, analysts say, points to increased appetite in the prospects for the Brazilian economy.

However, we think there are some more fundamental issues that still need to be resolved. Until these are addressed, traders could well see more opportunities to continue to short the Real.

Political corruption, at the highest level, continues to be a problem for Brazil, and can retard economic growth. Just this week Eduardo Cunha, the man who led impeachment proceedings against former Brazilian president Dilma Rousseff (also ousted on corruption charges) was himself found guilty of corruption, tax evasion and money laundering. This is the speaker of Brazil’s lower house we’re talking about, again, like the president he ousted, implicated in a deal involving state oil giant Petrobras.

Now let’s look at inflation in Brazil.

Inflation has been a major problem for the country. The rate of consumer price inflation started to slow down in mid-March, at 4.73%, down from 5.02%. Up until then it had been rising steadily. Brazil’s central bank reduced its base rate last month to 12.25% from 13% in recognition that inflation may be slowing down. Brazil’s target inflation rate is 4.5%. This is pretty good news, particularly when you consider that Brazil is forecast to have a trade surplus of $48 billion in 2017.

Yet you would expect Brazil to have a trade surplus of at least this. Brazil is a major exporter of raw materials and agricultural products. It should have a huge trade surplus. On top of that, anecdotal evidence from the street is not as rosy. A hedge fund acquaintance of mine visited Brazil recently and said that it is routine – routine, mind you – for stores not to expect to be paid in full for goods. Customers regularly pay a portion, even for small purchases, on an informal basis, and store owners take it on faith that the customer MAY settle their credit line in the future. There are still huge dislocations in the local economy and widespread poverty which need to be addressed, and too much wealth being retained at the upper echelons of Brazilian society.

Currency traders will argue that part of the value of the BRL is the price being paid for it by buyers of Brazil’s natural resources. As long as the coffee plantations and the oil fields keep working, there will be demand for the BRL, they argue. Indeed, we had considered adding the currency to our Short of the Week column, but you simply cannot discount that natural resources story. Brazil does, however, have major systemic problems within its political and financial systems. If global commodity prices do not pick up in 2017, these problems will become more assertive. Think of it like someone with a cold who is getting by with vitamin C tablets: if he runs out of vitamin C, he will fall ill quite quickly. That’s Brazil for you.

At the time of writing, the BRL was trading at 3.19464 to the USD. Over the last month it has been bouncing between 3.07 and 3.19. It seems to have seen off the worst of its weakness in 2014-15. However, as an emerging market currency it is still incredibly volatile and should only be approached by traders with the cash to keep their stops very wide of the mark. Massive single day reversals are par for the course with this one.

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Please note this article does not constitute investment advice. Investors are encouraged to do their own research beforehand or consult a professional advisor.

Stuart Fieldhouse

Stuart Fieldhouse

Stuart Fieldhouse has spent 25 years in journalism and marketing, including as a wealth management editor for the Financial Times group, covering capital markets and international private banking, and as an investment banking correspondent for Euromoney in Hong Kong. He was the founder editor of The Hedge Fund Journal.

Stuart has worked at CMC Markets, supporting the re-launch of its global financial spread betting and CFD trading platforms. He is also the author of two books on trading, published by Financial Times Pearson. Based in The Armchair Trader’s London office, Stuart continues to advise fund managers, private banks, family offices and other financial institutions.

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