Brazil: One of the Best Opportunities in Emerging Markets

by: Macro Man December 03, 2008 | about stocks: BZF / EWZ    

Macro Man

About this author:
Become a Contributor Submit an Article
  • Font Size:
  • Print

One of Macro Man's favourite themes at the moment is the necessity and likelihood of EM policy easing in response to the global recession and disinflationary/deflationary dynamic. For sure, most EM countries have eased policy to one degree or another - some of them aggressively. But a few EM CBs have stuck to their guns....for now. Therein lies opportunity. One of the best out there at the moment is Brazil.

The land of the Amazon has been a favourite target of macro punters for much of the past three years or so. Until the third quarter of this year, most of that focus was in the equity and especially the currency markets. There was little not to love about the BRL - where else could you get a currency with double-digit nominal rates, high single-digit real rates, and a current account surplus/commodity tailwind to boot?

Macro Man took a look at the BRL more than a year and a half ago and concluded (erroneously) that there was relatively little opportunity left in the currency. How wrong he was, as USD/BRL tumbled 25% in the ensuing 15 months.

Since then, of course, USD/BRL has subsequently rallied more than 50%. Was this justified? According to Macro Man's metrics, no. His favoured measure of real fair value, a terms-of-trade adjusted PPP measure, has suggested that the equilibrium level of USD/BRL has risen somewhat...but nowhere near the amount of the recent spot rally.

That, Macro Man would suggest, has much more to do with positioning. Sure, there were some stale foreign longs in BRL, but those surely threw in the towel by 2.00. The real story (if you'll pardon the pun) is the toxic positioning in the Brazilian corporate sector, which drove spot aggressively higher and some companies to the brink of bankruptcy. Today, onshore punters are long dollars to the tune of $13 billion, according to data from the BM&F.

While short USD/BRL will (eventually) be a nice global recovery trade, the time for it could easily be eighteen months away. No, for the time being he prefers the fixed income market, where slowing activity and a levelling off of inflation pressures have been reflected in yields with...err..exuberance.

Since the middle of November, yields across the curve have fallen more than 2% in some buckets, a very sizeable rally. The front few contracts are trading close to flat with the SELIC rate, but none are yet pricing in a cut. With industrial production virtually stagnant on a y/y basis now and indicators of global activity plumbing new depths seemingly daily, in Macro Man's view it's only a matter of time before the BCB sees the light and cuts.

That having been said, it's difficult to add/establish after a 200 bp rally, with much of it coming in thin trading conditions. It wouldn't altogether surprise to see a 50bp-plus pullback in the Jan 10-Jan 12 part of the curve.

If any sort of priced hiking is re-introduced, however, it looks like a nice opportunity. What's been especially gratifying about this trade recently is that it has exhibited zero correlation with the SPX.

Traditionally, EM fixed income trades more like a stock than a bond, rallying and falling with risk aversion. Some time last month, however, the DIs (exchange traded swaps) seemed to decide that they are, in fact, bonds, and the traditionally negative correlation between yield changes and changes in the SPX vanished.

This has made it an especially attractive trade, as it has escaped from the "risk on/risk off" mentality that has assailed most other assets in one way or another. Speaking to other macro punters recently, Macro Man has to accept that he is hardly alone in this view. But the crowd, as they say, can't always be wrong...and this is a case where fundamentals, current pricing, and thematic relevance make it one of Macro Man's favourites in an environment where equities seem to run around like a headless chicken.

Related Articles

This article has 7 comments:

  •  
    Dec 03 09:55 AM
    Jim Rogers says that Brazil will be the next great country in the world. It has always been , and it will always be.

    jimrogers-investments..../
    Reply | Link to Comment
  •  
    Dec 03 10:29 AM
    Short-term traders in currencies might as well be reading tea leaves. Before I bet on Brazil as the world's next Japan / South Korea / China I would like to know if they are taking the steps needed to raise a country out of long-term "developing" status. Are they adequately educating their children? How stable is their democracy? Are there safeguards in place to prevent the govt from paying for itself by printing money? If they are failing in these areas, we are only witnessing the equivalent of a Mexico rally. If they are serious about education, infrastructure, rule of law, and financial stability, then they certainly could be the next Japan / South Korea story.
    Reply | Link to Comment
  •  
    Dec 03 11:37 AM
    I am not so convinced that easing is likely. The problem I see for many EMs, especially those in LatAm is as follows. There is now and presumably will be continued significant downward pressure on their currencies. At a certain point they are going to have to stop using reserves to support the value of their currencies (or risk running out of them -- I haven't heard the latest figures for Argentina's reserve burn rate, but I imagine the controlled slide is costing them dearly), at which point they have to decide whether to let the currency fall or raise interest rates to support the currency. If they let the currency fall, inflationary pressures build (and, more immediately, corporate USD/Euro denominated debt becomes more expensive) and they are back to raising rates. I see easing as a possible outcome only if the fabled soft landing happens.
    Reply | Link to Comment
  •  
    Dec 03 11:54 AM
    Pipo if you like Jim Rogers so much why don't you go marry him
    Reply | Link to Comment
  •  
    Dec 03 12:17 PM
    I think Pimpo must be getting paid for his incessant, idiotic JR parrotings.
    No other explanation fits.


    On Dec 03 11:54 AM nelson mandela wrote:

    > Pipo if you like Jim Rogers so much why don't you go marry him
    Reply | Link to Comment
  •  
    Dec 04 08:16 AM
    What!

    I live here in Rio. People are losing their jobs. The currency is losing value fast. Stock market in tank. Credit crunch is about to hit big. Long long term investment is a maybe. Remember, the present admin of Lula is almost over. There is no successor worth mentioning. Be careful. Be scared.
    Reply | Link to Comment
  •  
    Dec 04 04:05 PM
    Mr. Man:

    I really enjoy reading your stuff and I know you're really, really smart. How do I know that? Easy.

    1. I can't understand half the things you talk about.

    2. You can afford a Bloomberg terminal.

    Your devoted, confused reader,

    Mike
    Reply | Link to Comment
More Comments on EWZ ยป
Top Rated Comment Streams:

Numbers are net rating-

See all Top 100 »
More by Macro Man

Investment Resources
Money Management
Research
Seeking Alpha provides these ads as a service to its leading contributors
Articles on related themes
Brazil
Latin America
Dollar/Currencies
Asia