Brazil: What's Going On? Currency Vs. Inflation

Includes: EWZ
by: Emerging Money

By Tim Seymour

Nobody knows what is going on with the currency in Brazil. After months of targeting a weaker real, the Brazil Central Bank could be changing course -- and it may have to. All of this is leaving investors with a little Brazil whiplash, as this market remains the biggest disappointment in emerging market equity land after two years of underperformance.

Today's local newspapers are saying the Brazil Central Bank will use real appreciation to tame inflation. Yet if you listen to President Dilma Rousseff, she said yesterday that "we have macro conditions to still reducing interest rates."

Well, what is it? Are you lowering rates and putting more downward pressure on the currency, or are you letting the currency appreciate in order to stem inflationary pressures that are building? Maybe it's politics, but the government keeps endorsing incentives to consumption and investments.

Meanwhile, reducing the SELIC (special clearance and escrow system) rate runs in the opposite direction of Brazil Central Bank's interest in using the currency to fight inflation. For now, Rousseff looks to keep spending to stimulate, and there is political motivation to do so. Brazil's consumer will keep spending, but be wary -- there may be slower consumption ahead. The consumer space has been the only safe place to invest in Brazil for two years, but this may be changing.