When will the BRL deliver?

I don’t know when it will deliver.

Real-carry wise: it shouldn’t, really. Real carry differential is at lows since BRL was established as new currency in Brazil (~1994).

But odds are that BRL will do well vs USD when brazilian GDP growth shows up, meaning there’s stronger confidence, economy-wide, that profits are for real. FDI ramps up, speculative capital follows (momentum traders).

On a Global Macro basis that should also require a benign global environment where global capital allocators feel like sticking their neck out to invest in EM, when capital repatriation isn’t a goal where legacy wealth is from (Japan, Europe, UK, China, US, Switzerland).

Quick update from months ago (here):

– External accounts are healthy despite revisions lower in FDI + Curr Account (from high of 4.1% to current 2.8% on L12M basis) as exports are well and internal demand is poor, helping maintain low imports;
– Brazilian businesses – the ones that survived the almost 3y recession – cleaned up their mess (expenses, balance sheets) and are operationally very, very sound;
– Inflation volatility should decrease due to still high slack in economy (mfg, labor, right-wing govt focused on balancing budget);
– We’re making new lows in long-term real yields, which will help businesses/growth AND the country’s budget balance (lower interest expense);
– We’re closer to passing an important Pension Reform, larger than was expected from Temer;
– Privatizations are on the table and I expect them to move even faster after Pension Reform is over with. Govt won’t have to be “nice to opposition” when such big item leaves table.
– Bolsonaro has given whatever room needed for Paulo Guedes and other technical lads to work. Follow Tarcísio Freitas (Infrastructure Secretary) on Twitter.
– And… BRL is cheaper than it was.

Virtuous Cycle:
– Low relative yields are making brazilian companies stop issuing debt in foreign currency because the currency risk isn’t worth it anymore. In due time this reduction in foreign liabilities will break the weak link some EMs have, of depending on foreign capital that flees the country when the shit hits the fan domestically or globally.

The cons:
– Political scenario has deteriorated from 2014-2018 period in my view. Bolsonaro doesn’t sound smart in portuguese, now I imagine foreigners reading about him in the FT or WSJ when even in brazilian media he’s hated. His son Flávio Bolsonaro, possibly involved in corruption, might be making him a clown in the fight against corruption he was so vocal about during elections.
– In my view there’s a risk the Left comes back in 2022, but a/ we’re too far away from that, b/ there’s risk of other good candidates showing up, but c/ I think Brazil will improve considerably before the next elections.
– I’m not optimistic at all about US and global growth into the next 6-18 months.

Summary:
– BRL will deliver when/if Brazilian equities keep delivering. I don’t expect BRL to move higher x G3 if equities aren’t doing well.
– Brazilian equities a better way to be long BRL (EWZ [PBR, VALE + fins large in it], EWZS [more domestic, smaller names], PBR, VALE, BRMSY)
– BRL vs other non-G3 currencies I believe make sense now on a stand-along basis.

The fund is net-long BRL in its currency book (shorter-term bet, since 4.10 USDBRL) and long brazilian equities and long long-end of swap curve + linkers.

Charts below.

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