News & analysis

The Brazilian real has seen a significant rally against the US dollar in Q2, with gains over 13% recorded since the March bottom. The real’s surge has taken place despite a grim backdrop of Covid infections throughout the country and a slow pace of vaccinations, thus far disappointing our short calls over the past months. A number of factors have offset the damaging impact of the pandemic on the currency, placing the real in a firm bullish channel at present. The stronger-than-expected dollar downside has been a major theme dominating the FX narrative in emerging markets, with BRL the best outperformer so far in Q2. Domestically, the hawkish shift in monetary policy has brought back substantial carry to the real, with hikes totalling 150bp since mid-March and a robust normalisation agenda in sight suggesting this tailwind is only going to increase. Favourable current account dynamics on the back of improving terms of trade and booming commodity prices have added to the positive currency outlook too. Crucially, the fiscal data has started to show a positive impact from higher inflation, as tax collection improves due to higher prices of goods and services while inflation adjustments on spending in areas like state pensions are slower to adjust. The mild fiscal relief has contributed to a significant reduction in economic and policy uncertainty, further boosting the currency’s appeal as a result. Looking ahead, the Brazilian real should extend its gains amid a stronger growth environment. However, risks to this view remain heavily tilted to the downside as a potential third wave of infections looms on the horizon.

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