The Perfect Storm for the Brazilian Real
Russia's invasion of Ukraine boosted the Brazilian Real in 2022 and it's happening again
We know two things about the war with Iran: (i) at this point, the US administration wants the war to end as quickly as possible; and (ii) Iran has genuine leverage in the form of the Strait of Hormuz. The goal of talks between both sides is to find a face-saving exit that allows both sides - especially the US - to claim “mission accomplished.” That’s no easy task because it’s practically impossible to claim victory as long as the Strait remains closed. I can imagine we end up with what on the surface gets sold as a joint “toll” system, which in truth boils down to Iranian control for the time being. This’ll involve some fancy footwork on wording, but that’s eminently doable.
But the main point isn’t the details of how this gets worked out. Instead, it’s that the US administration wants this war over as quickly as possible because of the looming midterm elections. This takes catastrophic escalation off the table, giving markets the confidence to go back to high-beta, risk-positive plays. The same happened in 2022 after Russia’s invasion of Ukraine. Once markets figured out that things weren’t going to spiral out of control, the Brazilian Real - the embodiment of a high-beta currency - took off in a big way. As I flagged in a post right after this war began, Brent rose 40 percent in Q1 2022. The Brazilian Real rose 20 percent and outperformed everyone else. With catastrophic escalation off the table, that’s now happening again.
The blue line in the chart above shows the bilateral $/BRL exchange rate. When this line falls, it means the Brazilian Real is strengthening versus the Dollar. When it rises, the Brazilian Real is weakening. The black line is my estimate for $/BRL fair value at 4.50, which I’ve had for many years. This estimate might appear fantastical, since the blue line is pretty much only above this fair value in recent years. But that ignores that $/BRL spent the decade before COVID well below 4.00. The truth is that Brazil’s Real is horribly beaten down and undervalued.
So what now? Two things come together to form the perfect storm for Brazil. First, the US wants to end this war as quickly as possible. That’s risk-positive and lifts high carry currencies like the Brazilian Real. Second, uncertainty over the Strait of Hormuz means oil prices will stay elevated for some time. That disproportionately benefits the Brazilian Real because it’s a big oil and commodity exporter. In 2022, we never quite made it below my fair value of 4.50, but I think that’s now in play. I expect the coming months to see $/BRL finally go below 4.50.
If memory does not fail me, the Brazilian Real has been among the best carry trade opportunities for a while - to your point; any thought as to WHY that might be?
The Brazilian economy is odd in that most domestic capital just wanta to park itself outside the country while the stock market just keeps growing and growing with the influx of foreign capital...
Sounds weird that Brazilians would willingly and systematically just miss out on making money in their own back yard
The estimates that local economists stabilish for real is around R$ 5.50 for each dolar, due to speed public spenditure has been growing, without any means of control. I dont think 4.50 makes sense. Fiscal risk has put BRL above 6.00 Just recently. What would explain 4.50 as a fair value?