Brazil, Get Real!

So we postponed publishing Friday till after Ben Bernanke’s Jackson Hole address on the expectation there might be some juicy commentary to make. As it turns out though, pretty uneventful! No QE3 just yet but to keep us in suspense Bernanke announced that the Fed would consider additional tools to help stimulate a US economic recovery in September……

For the USD next week, Jackson Hole will probably be a non event. Interest rates can’t go much lower, they’re certainly not going much higher just yet, inflation hasn’t been spiked by Quantitative Easing and yet Bernanke hasn’t held off because he is confident that the economy is righting itself. All in all it’s a tough read on the near term direction for the USD.

Faced with this predicament we turn to a much under-discussed currency given Brazil’s economic growth profile. The Brazilian economy is flush with natural resources and home to one of the mining powerhouses of the world, Vale. Vale is the world’s largest producer of iron ore. It accounts for 60% of Brazil’s iron ore and supples around 15% of world trade in iron ore.

As such the Brazilian Real (BRL) ticks two currency boxes. Firstly, it’s an emerging nation currency and secondly, it’s a resource rich/ China linked currency. This gives the Real an interesting profile of similarities to say the AUD (obviously the commodity angle) but also to the Mexican Peso (emerging market angle).

The BRL has had a tough time in the last month. Faced with the double headwinds of “a flight to safety” in currency markets and a regulatory issue where the Brazilian Government introduced a tax on currency derivatives that has limited BRL currency speculation.

Couple this with the recent release of The Economist’s Annual Big Mac Index which named the BRL as the “World’s Most Overvalued Currency” in Purchasing-Power-Parity terms showing an overvaluation of 149% against the USD makes for a currency facing some pretty significant headwinds!

There are a couple of angles to play on the BRL with possibly quite different short term pressures compared to longer term tail winds. As such any BRL/USD trade should most probably be hedged for protection given the inherent difficulty in guessing time frames on how and when these things play out.