Brazilian Real - It's Easier To Fall Than It Is To Climb

Includes: BZF, EWZ
by: Dmitry Lifatov


In 2014-2015 the Brazilian real experienced a sharp depreciation, caused by the severe recession in the economy of this country, with traders simply applying a “buy-and-hold” strategy to USD/BRL.

Since then, USD/BRL rebounded by more than 23%, returning to the fundamentally justified levels.

The future performance of this pair is heavily data-dependent, and we should not simply change our strategy to the “sell-and-forget” approach.

Although in the long-term the odds are somewhat in favor of a continuation of the descending trend in USD/BRL, right now there is no too much macroeconomic evidence to support this case.

In the period from September 2014 to September 2015, the Brazilian real was one of the easiest and most favorable currencies for trading. High volatility (AMV in this period amounted to 5.84%), coupled with a presence of a fundamental trend, allowed for many institutional traders to apply to USD/BRL a simple "buy-and-hold" strategy, making a profit equivalent up to a 90% decline within just one year.

Such exceptional weakness of this currency was caused by a combination of an enduring political crisis and a deep economic recession in Brazil, which produced a so-called "perfect storm" in this country. For us, nevertheless, the most interesting part is related to the future dynamic of an exchange rate between the U.S. dollar and Brazilian real.

The current situation in the Brazilian economy is similar to a boxer heavily knocked down and trying to regain his feet. The outcome of these attempts is still questionable; however, it is obvious that it will not be a V-shaped recovery, with IMF projecting a slow real GDP growth in this country of just 0.3% y/y in 2017 and 1.8% y/y in 2018. With such low numbers, among 27 Latin American countries, mentioned in this IMF outlook, Brazil holds a 24/25th place in 2017 rivaling Trinidad and Tobago in terms of the biggest growth rate, and shares 23/24th place in 2018 on a par with El Salvador. The IHS Markit Brazil Manufacturing PMI in October 2017 edged higher to 51.2 - although a significant increase from 44.0 in January 2017, but still around a 50.0 threshold level, separating expansion from contraction. Moreover, since June 2017 it is almost flat, already for five consecutive months. The IHS Markit Brazil Services PMI Business Activity Index in October 2017 fell quite considerably to 48.8 from a 50.7 level in the previous month, but such rapid fluctuations of its value are quite common for this index over the recent eight months. Business confidence in Brazil rose to 56.5 in November 2017, up from 50.1 at the beginning of the year; consumer optimism is more cautious, decreasing to 101.2 in October 2017 from 103.8 in January this year.

The CPI index in Brazil in October 2017 stood at the level of just 2.7% y/y, yet slightly rebounding off the 2.46% low, achieved in August this year, which by the way was the slowest pace of growth in consumer prices since 1999. The core CPI in Brazil amounted to 3.98% y/y in October 2017, which is also very low as compared to its historical values. Producer prices in Brazil have been demonstrating negative growth since May 2017, decreasing by 3.5% y/y in September 2017. The same dynamic we saw in 2009 during the recent global economic crisis, which proves once again the severity of the latest recession in Brazil in 2015-2017. The unemployment rate in Brazil is pretty high, standing at 12.2% in the three months to October 2017. Such high rate is not surprising taking into account the recent economic recession. In fact, apart from the stubbornly high unemployment, another acute problem for the Brazilian economy is a high rate of underemployed citizens, which together with the jobless people amount to almost 20% of the total population.

In an attempt to pull the economy out of recession, the Central Bank of Brazil - BACEN - progressively cut interest rates, which are now at the level of 7.50%. We should mention that historically, interest rates in Brazil are significantly higher than in the developed countries, with an average value of 15.5% in the period of 1999-2017. The current value of the Brazilian interest rate is well below its normal conditions. In fact, the Brazilian central bank during its meeting on September 06, 2017 signaled a gradual end to the monetary easing, and market participants now believe that the most recent interest rate cut by 75bps in October 2017 can be the last one in the current cycle of monetary easing.

The attempts of the Brazilian government to restart the national economic engine have produced a mixed result so far. That is why I remain rather cautious on the probability of a strong continuation of the real's appreciation, deliberately refusing from applying a "sell-and-forget" strategy. The traders have already returned the USD/BRL exchange rate to its more fundamentally justified levels. From an all-time high, achieved in September 2015 around the level of 4.2400, to a present value at 3.2450, the Brazilian real rebounded by more than 23% versus its U.S. counterpart.

To support my thesis, I provide some interesting statistical comparisons based on the analysis of historical data of USD/BRL movement [see the attached Excel file USDBRL-calculations.xlsx]. Since 1999, when Brazil floated the real, the AMV of USD/BRL exchange rate stood at the level of 3.76%. The period of appreciation of the Brazilian real in 2004-2008 lasted for 1491 days (approx. 4 years, from June 2004 to July 2008), when USD/BRL fell by 50.99% with AMV standing at 2.97%. The recent Brazilian real depreciation lasted for only 365 days (1 year, from September 2014 to September 2015), but the magnitude of USD/BRL growth at that time was just enormous, +89.92% with AMV at 5.84%.

Here are the main points to consider:

  • USD/BRL in 1999-2017: AMV at 3.76%, AMV of up months is 4.37%, AMV of down months is 3.17%, difference at 1.38;
  • USD/BRL fall in 2004-2008: 1491 days (4 years), -50.99%, with AMV at 2.97%;
  • USD/BRL rise in 2014-2015: 365 days (1 year), +89.92%, with AMV at 5.84%.

Judging from this comparison, it becomes evident that the Brazilian real generally tends to fall in value on average in 1.38 times higher than to rise. If we compare the periods of a clear fundamental bias (2004-2008 and 2014-2015), this difference becomes even wider, with the Brazilian real falling in 4 times quicker and almost in 2 times higher than appreciating in its value.

Thus, the deep economic recession, which struck Brazil in 2015-2017, is gradually fizzling out. The probability of some sort of a recovery is rising, but this is by no means guaranteed, especially taking into account the newly intensified political struggle, related to the corruption charges against the president of this country. Right now, I would not bet heavily on a progressive USD/BRL downward movement, although in the long-term the odds are somewhat in favor of a continuation of the descending trend. Still, we need a clearer confirmation of the Brazilian economy, recovering from the consequences of its "perfect storm", to start actively buying the Brazilian real versus the U.S. dollar. Currently, I do not expect too much momentum on the downside in this pair. As the historical data has proved, for the Brazilian real it's easier to fall than it is to climb.


AMV stands for an average monthly volatility, calculated as the arithmetic average of monthly percentage changes.

All data on values of macroeconomic indicators, if not stated otherwise, come from

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I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.