BRL Carnivale

The famous celebration of Carnivale in Brazil occurs 40 days before the Christian event of Lent. Hence Carnivale usually takes place around February each year. So while the drums start beating and the samba dancers practice for the parades, here at FX Strategy we just keep our heads down and think about the recent appreciation of the BRL and where it might go from here.

As our chart last week showed, the BRL is up over 5% so far in 2012. The big question for FX strategists is: Is this the beginning of a sustainable strengthening of the BRL or will the Brazilian government intervene to depreciate? The central bank recently cut interest rates and the market expects more to come. This is from a high base of 11%, so there is definitely room for the central bank to move.

The main argument for a “real” appreciation (I hope readers enjoy a good pun- or a bad one!) is an inflow of foreign funds seeking out Brazil’s commodities and financial markets. Foreign Direct Investment (FDI) is forecast to have reached approximately $100 Billion in 2011 and expectations that it will be even higher in 2012. Brazil is a vibrant economy and holds much potential as a leading emerging market.

A difficulty with a BRL:USD paired trade is the potential for the US economy to bounce back – as certain recent leading indicators are suggesting. As such this pairing could become a battle for which economy has not only the stronger growth rate but which economy’s growth rate surprises market watchers more on the upside. What we mean by this is, it’s not the expected news which is already priced in where you will make money on your FX trade but it’s where your insights help you accurately predict what isn’t currently priced in!

For this reason we think there may be more potential in a BRL:EUR pairing or a BRL:GBP pairing because we have confidence in Brazil’s economy outperforming the euro zone and Britain and expect that this may flow through into sustained support for the BRL.

As always, do your own research and analysis and seek professional financial advice as you develop your FX strategy and remember than leverage is a dangerous tool so use it carefully.