Short USD/BRL on BCB’s Aggressive Tightening Cycle, Attractive Brazilian Real Carry
The Brazilian real has been one of the best performing emerging market currencies during the second quarter of 2021, gaining more than 14% against the US dollar. BRL’s remarkable recovery may still have legs going into the third quarter, supported by improving economic activity in the Latin American country, but most importantly by the aggressive tightening cycle undertaken by Brazil’s Central Bank COPOM.
COPOM started raising the SELIC rate in March from a record low of 2.00% to contain rising inflationary pressures and to regain credibility on its commitment to bring down consumer prices. After three consecutive 75 bps adjustments, borrowing costs reached 4.25% in June, the highest level since early 2020 before the COVID-19 pandemic broke out.
BCB’s forceful rate-hike front loading is set to continue over the next few months, with the central bank expected to increase the SELIC rate by another 75 bps in August to manage runaway inflation risks.. Investors seem convinced that the withdrawal of stimulus will accelerate during the second half of the year and now expect the central bank's benchmark rate to end 2021 at 6.50%, 125 basis points above its current level.
BCB’s rising yield differential with the Fed will boost the Brazilian real’s carry attractiveness, reinforcing its appreciatory trend against the US Dollar over the medium term. Meanwhile, sovereign risk-premium compression and reduced near-term fiscal worries on better-than-expected GDP growth should add momentum to the real.
For all these reasons I am bearish USD/BRL and expect more downside going into the third quarter, but to entertain any short positions I would personally wait for better entry levels, perhaps near a technical resistance zone. In the daily chart, I am watching closely the April descending trendline resistance, now near the 5.00 psychological level. If USD/BRL rebounded briefly, it could stall in that area before heading back towards the June 2020 low (4.81) in the coming months.
USD/BRL Daily Chart
Chart prepared by Diego Colman using TradingView
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