Conclusion: We don’t anticipate the Brazilian government’s latest attempt to curb the real’s appreciation to be successful, and thus, we remain in wait-and-watch mode on Brazilian equities and Brazilian fixed-income securities. If, however, the real starts to weaken materially, we want to be short both Brazilian equities and bonds.
Position: For clarity, let’s revisit our recent calls on Brazilian assets:
- May 2010: Bearish on Brazilian Equities
- June 2010: Bullish on the Brazilian Real
- July/August 2010: Bullish on Brazilian Equities
- November 2010: Bearish on Brazilian Bonds and Bearish on Brazilian Equities
- March 2011: Less Bearish on Brazilian Equities (wait-&-watch mode)
Late yesterday, the Brazilian government decided to implement further measures in the latest installment in a series of attempts to stem the real’s appreciation. Up nearly 55% since it bottomed in December ’08 and +1.6% YTD, the real’s persistent strength continues to be a thorn in the side of Brazilian exporters and policy-makers alike.
Perhaps more so than previous efforts, the latest measures are more directly targeted towards cooling speculation than actually stemming inflows of capital. This is positive on the margin, especially considering Brazil’s long-term capital needs to build out its woeful infrastructure in the coming years.
Whether or not the newly imposed +6% tax on international corporate debt sales and loans with an average minimum maturity of up to 360 days actually weakens the currency over the intermediate term remains to be seen, as the real’s gains YTD have been driven by longer-term fundamentals and USD weakness, rather than the performance of Brazilian financial markets.
In fact, central bank data suggest net foreign currency inflows in 2011 are actually much more linked to long-term investment and not just speculation. Indeed, the yield-chasing flows to Brazil’s equity and bond market have slowed measurably, as foreign investment in Brazilian stocks and bonds fell (-91.4%) YoY in Jan to $206M, while foreign direct investment grew +393% YoY to $3B. Altogether, net foreign currency inflows for 2011 YTD ($24.4B) already exceed the full year 2010 total.
The 6% tax is in addition to the already-established 5.38% tax on loans up to 90 days and the newly announced +400bps hike in the foreign consumer credit card transactions tax to 6.38%. Today’s measures are a continuation of recent attempts to curb real appreciation, which include: tripling a tax on foreign purchases of Brazilian fixed-income securities to 6% in October, buying $18.8B US dollars in the spot market in the first three months of 2011 alone (45% of full-year 2010 total), buying US dollar in the futures market for the first time in 21 months, and raising reserve requirements on short dollar-positions held by local banks in January.
All told, we don’t expect these latest measures to materially weaken the real over the intermediate term. If, however, the Brazilian government is successful in weakening the real, we want to be outright short Brazilian local currency bonds, a position supported by (hypothetical) currency weakness and incremental inflationary pressure driven by rising import costs.
It’s important to keep in mind that the real’s ~10% appreciation over the last 12 months has acted as a governor on Brazilian CPI. Should that reverse, we could continue to see the central bank struggle to rein in accelerating inflation. Not ironically, the central bank raised it 2011 CPI outlook to +60bps to 5.6% alongside the release of yesterday’s FX intervention measures.
Further, with the central bank raising its inflation forecast and credit growth accelerating far beyond the Tombini’s +15 YoY target, we could foresee a scenario whereby the central bank continues to raise interest rates beyond the upcoming monetary policy meeting on April 19-20. That would be counter to current consensus expectations of a pause after that meeting and would be incrementally bearish for Brazilian equities over the intermediate term.
If the status quo remains from an inflation expectations perspective and a foreign exchange rate perspective, we’d still continue to urge caution on Brazilian equities, as they are broken from an intermediate-term TREND perspective. We’d need to see a sustained breakout above the TREND line on the Bovespa before we’re comfortable getting long Brazilian equities, as that would signal to us Brazilian Stagflation is fully priced into the market.
On the flip side, a breakout in global financial market volatility stemming from the buy-side reacting to a reported deceleration in US and global growth that we’ve been calling for will surely put a damp on non-energy related risk assets over the medium term.
For more on the intermediate term outlook on Brazil, please refer to the more comprehensive report we published last week titled “Brazilian Tug-of-War”. Please email us if you need a copy.