In an article last month we were looking for the USD to rise on the Brazilian Real and we broke out to the upside but there is far more strength ahead in our view. The fundamentals for the BRL are bearish…
The Brazilian Real is still the best performing emerging market currency for 2022 so far but it’s starting to fall now and the fall could accelerate.
Brazil’s central bank’s monetary policy committee increased the Selic interest rate by a full percentage point to 12.75% last week but warned of a smaller rise next month.
Brazil is struggling with high inflation with consumer prices rising more than 12% in April.
While aggressive hiking is needed to tame inflation there is a cost in terms of the outlook for the economy.
Economic growth will probably be below 1% annually for the next two years according to a central bank survey of analysts.
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The central bank’s monetary plan is following the script to address this stubborn inflation.
“Monetary restriction will subdue it but also impose a cost on the economy’s recovery.” (Alfredo Coutino, director at Moody’s Analytics)
The interest rate is attractive but the outlook for the economy is gloomy going forward and there are two big bearish fundamentals.
The BRL is heavily correlated with the Chinese economy which is slowing up and a falling Yuan is also weighing on the Real.
We also have the Fed which is hawkish in terms of interest rate rises and they are also reducing their balance sheet. For a country that relies on heavy USD inflows, this is long-term bearish.
In conclusion, we agree with this view:
“The domestic outlook remains challenging due to economic policy uncertainty with the electoral cycle in a global environment of monetary policy tightening with higher risk aversion stemming from a more hawkish Fed COVID-19 lockdowns in China and the geopolitical landscape. Thus, we see further room for the BRL to depreciate and remain undervalued against its fair value over the coming months.” (RABOBANK)
In terms of the monthly chart, we have pushed off the 5.00 support level and have a target of the top of the channel at 5.7500. We view the USD as a buy with stop protection behind second-level support at 4.900.