Brazilian Real’s Bumpy Days Hint at Tough Path Out of Losses

(Bloomberg) -- Brazilian real traders are facing a rough start to the year.

The currency has lived up to its reputation as the most volatile in the world, changing course midway in every session in 2021 so far.

The wild swings give a hint of what investors can expect ahead. While analysts forecast the real will strengthen about 4% to 5 per dollar in 2021, breaking a four-year streak of losses, they say the ride will be bumpy as fiscal and political uncertainty leave the currency more sensitive to global drivers than peers.

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“We do not expect this trend to be a steady move,” said Luis Hurtado, a Latin America currency strategist at Canadian Imperial Bank of Commerce in Toronto, who has one of the most bullish forecasts for the real this year, according to a Bloomberg survey.

Hurtado sees the real gaining toward 5 per dollar in the first quarter and to 4.5 by the end of the year depending on the speed of reforms and virus developments. In the short-term though, the currency could slump to 5.6 per dollar, he said, if the government extends the emergency aid payments to informal workers, a measure that would jeopardize the nation's fiscal consolidation efforts.

The real has weakened about 40% in nominal terms in the past four years as the central bank slashed interest rates to 2% from 14.25% in late 2016, killing what was one of the most attractive carry trades in the world. Last year, the currency fell 22% as the government doled out some $57 billion in cash to fight the pandemic-driven crisis. It has fallen every year since 2011 with one exception, going from about 1.66 per dollar at the end of 2010 to 5.19 at the close of 2020.

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The start of 2021 wasn't much different. The real is underperforming all emerging-market currencies except for the South African rand, on concern about a pickup in virus cases around the globe and fears that Brazil's government could adopt a less austere fiscal stance. The central bank has stepped in twice to curb losses, including on Monday. The currency is down about 5.3% this year, trading at around 5.49 per dollar.

Catching up

While the fiscal and political backdrop is convoluted, analysts say the real has room to catch up with peers and could even outperform in a global risk rally.

It's a “sort of ‘rising tide lifts all boats' argument,” said Sacha Tihany, the deputy head of emerging markets strategy at TD Securities in Toronto. “As we know Brazil has very serious fiscal issues to contend with.”

Tihany was the most accurate forecaster for the real in the second quarter of last year according to a Bloomberg ranking and sees the currency at 4.75 per dollar by the end of 2021, assuming the government respects the spending cap rule that limits the increase in public expenditure to the inflation rate.

Juan Prada, a New York-based currency strategist at Barclays, said cheap valuation and light positioning set the groundwork for the currency to strengthen at the start of the year. The bank was among the most accurate forecasters for the real in November according to the Brazilian central bank's ranking and forecasts it at 5.05 per dollar by mid-year and 5.25 by year-end as fiscal concern comes to the forefront in the second half.

“Long run valuation metrics suggest the real is cheap,” Prada said. “But there are reasons for that cheapness.”