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Covid Virus Risks Weigh on Latam FX; USD/BRL and USD/MXN Spike Higher

Covid Virus Risks Weigh on Latam FX; USD/BRL and USD/MXN Spike Higher

Diego Colman, Contributing Strategist


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Brazilian real and Mexican Peso Outlook:

  • Latin American currencies weaken on coronavirus risk in the first day of July
  • The Brazilian real leads losses and tumbles against the U.S. dollar, Mexican peso also falls, but its decline is more moderate
  • On Friday, investors’ attention will shift to the U.S. employment report

Most read: U.S. June Manufacturing Cools but Stays on Growth Path, Dollar Ticks Higher as NFP Comes in Focus

Latam FX began July and the second half of the year with a negative bias, weighed down by concerns about the more contagious Delta Covid variant affecting many countries. Vaccination rates are advancing at a maddeningly slow pace in Latin America, so the presence of a more transmissible strain of the novel coronavirus poses serious risks, as it may weaken economic recovery and slow the tightening cycles started by many central banks in the region. In this context, USD/BRL surged 1.4% to 5.0620 while USD/MXN jumped 0.3% to 20.00 in the first trading session of the month.

With only one in 10 people fully vaccinated so far in Latin America, according to the Pan American Health Organization, the end of the pandemic remains a distant future. This means that new outbreaks could emerge at any time and lead to another round of restrictions/lockdowns, a sentiment shared by many virologists. Meanwhile, political risks in Brazil, amid growing calls for the impeachment of President Jair Bolsonaro for his mismanagement of the health crisis, are beginning to weigh on investor confidence, exacerbating the sell-off in the Brazilian real.

Although political noise and COVID-19 risks in the region may trigger temporary routs from time to time, the medium-term outlook for currencies such as the Mexican peso and the Brazilian real has not changed materially and continues to be constructive.

In any case, the narrative may change slightly if US economic data gains momentum, as these developments would strengthen the case for Fed monetary tightening at a time when rising inflationary pressures are not letting up. For this reason, it is important for all traders to closely follow the employment report due for release on Friday.

Traders expect nonfarm payrolls (NFP) to increase by 700,000, within a range of expectations of 400,000 to 1,000,000. Anything close to 1 million or above that mark will keep alive the perceived risk of a QE tapering announcement in late summer or early fall, driving long-term Treasury yields higher. A large upward move in nominal yields could trigger a significant sell-off in EM FX such as MXN and BRL. As a reminder, emerging market currencies are very vulnerable to higher interest rates in the US.

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USD/BRL has rebounded moderately in the last few days, rising from a year low of 4.9090 to 5.0620 at the time of this writing. Despite this upward move, the pair remains in a negative medium-term trend, as seen in the daily chart, where the price establishes lower highs and trades below a 3-month descending trendline as well as its 200-day simple moving average. Against this backdrop, as price probes critical resistance near the 5.0620/5.0650 area, the technical bias points lower. That said, if we see a rejection from current levels, USD/BRL could return to its 2021 low. A break below this key floor would expose the June 2020 low near 4.8550. On the flip side, if buyers manage to push price above 5.0620/5.0650 decisively, USD/BRL would have fewer obstacles to reach the 5.1500 mark.


USDBRL technical chart


---Written by Diego Colman, DailyFX Market Strategist

Follow me on Twitter: @DColmanFX

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.