Emerging Market FX: USDBRL Fundamental & Technical Set Up

USDBRL Brazilian Real

The official currency of Brazil, The Brazilian Real (BRL) is divided into 100 centavos.

The modern era Real was introduced in 1994 to stabilize a depressed Brazilian economy. At its inception, the exchange rate was one Real to one USD. From the years of 1996 to 1998, the Brazilian Central Bank managed the exchange rate. In 1999, the newly elected President of the Central Bank took the decision to allow the currency to float freely, and the Real suffered massive devaluation, most dramatically against the USD, where it devalued by 100% overnight to two Real’s to One USD. Since its flotation, the Real has breached parity against the USD once in 2007 trading at 0.5 Real to one USD.

Brazil’s free-market economy has developed dramatically since 2000 at its height of development registering GDP growth of five percent and pegging it as one of the fastest growing economies in the world. By nominal GDP as of 2015 data, the Brazilian economy is the seventh largest in the world. However cracks have started to appear in the development story principally driven by higher unemployment data and depressed domestic growth and a series of domestic corruption scandals.

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Downgrades

At the end of September, credit rating agency Fitch downgraded Brazil to BBB- this action saw the USDBRL surge. The major implication of the downgrade action by Fitch is the economic outlook remains negative, which leaves the door open to further downgrades ahead. One area of concern for the agency is the continuing fluidity of the political landscape. On the positive side for Brazil; its bonds have been trading at junk status for the past couple of months and from a market perspective on an implied basis Brazilian bonds have been trading at a ‘BB’ level, which means they are trading two notches below the Fitch level while the market remains relatively orderly.

The big question is what will happen if Brazilian debt officially becomes junk-rated (this status is achieved when two or more agencies downgrade the domestic debt). Traditionally when this type of action occurs it requires index investors to unwind their exposure as the bonds would automatically be removed from listing on global bond indices. This position adjustment would like apply further downside pressure to the Real.

Just this weekend political concerns re-emerged with a magazine article suggesting that Finance Minister Levy is ready to immediately tender his resignation, due to disagreements with President Rousseff regarding economic policy.

The Finance Minister isn’t supportive of further easing policies to help stimulate domestic growth. Further press reports suggest that the President has already consulted a former Central Bank head regarding replacing the Finance Minister. The reports states that replacement by the former Central Bank Head Meirelles is dependent on conditions, principally granting autonomy two appoint key members of the Finance team. Rousseff is unlikely to agree to these conditions as they may complicate the picture for pushing through more monetary easing.

Domestic Data

Figures released by the BCB in the form of their ‘Focus Survey’ of major market participants continue to suggest that higher inflation persists while GDP forecasts continue to decline. The consumer price index rose to 9.75% from 9.70% in the latest release, median forecasts of administered prices remains unchanged and elevated at 16.00%. These forecasts reflect additional concerns around Real deflation, with year-end forecasts for the Real standing at BRL4.00/USD. GDP forecasts fell further to -3.00% from -2.97% previous.

Trade Troubles

A further hindrance to the Brazilian economy concerns its trade data with the trade balance showing a surplus of 777Mln USD. The surplus is driven by a decline in exports of oil and soybeans. Exports year to date have fallen to just 15.7% principally due to the decline in commodity prices. Imports have also declined to 22%, underpinning concerns regarding domestic recession, low oil prices and the weaker Brazilian Real.

The Issues regarding the political landscape and the continuing depressed domestic data hold little hope for the Brazilian economy and its is becoming increasingly likely that another rating agency will join Fitch in downgrading the countries debt rating, the big question is will this come before the year end or in early 2016. A second downgrade coupled with a potential rate move by the US could hammer the domestic currency and see a significant overshoot of the BRL4.00/USD market participant end of year forecast.

So now we have a high level view on the fundamental driver lets jump into the charts for a review of the technical landscape.

Technical takeaway

On the weekly scale the USDBRl is tracking a clear uptrend. Support on the weekly scale comes in at 3.7 while resistance is highlighted at 4.15

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Trading Take Away

Now lets drill down to our trading timescale, the daily scale and see where the near term trading locations can be identified. On the daily scale there appear to be two premium locations that I am going to be monitoring in the weeks ahead. Essentially I will be looking to align with the weekly trend using two support levels.

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  • Firstly, I will monitor any pull back to test support towards the 3.700 level watching for intraday reversal patterns to position on the long side targeting a retest of 2015 highs
  • Secondly, if a deeper correction manifests I will be closely monitoring intraday reversal patterns on a retest of major trendline support  and equality corrective leg completion toward 3.400 to position on the long side, again targeting a retest of 2015 highs

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