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Brazil real rebound on hold as 2021 kicks off on back foot

Jamie McGeever
·3 min read

By Jamie McGeever

BRASILIA, Jan 11 (Reuters) - Brazil's real has started 2021 on the defensive, sliding to a two-month low against the dollar despite a growing consensus that the tides of economic growth, interest rates and commodity prices are turning in its favor.

Data from U.S. futures markets on Friday showed that funds are their most positive on the real since 2019, and a central bank survey of economists on Monday showed that 2021 and 2022 rate forecasts are the highest since the middle of last year.

Yet despite tumbling below a key technical level late last year toward 5.00 reais, the U.S. dollar has snapped back above its 200-day moving average and on Monday nudged a two-month high above 5.50 reais.

What gives?

Rising U.S. bond yields and a strengthening dollar have provided a negative global backdrop for emerging market currencies, particularly the real, analysts say.

"The real's price action is primarily a function of global markets," said Paul McNamara, investment director at asset management firm GAM in London. "Heavy positioning into EM currencies at the start of the year, combined with a bounce in the dollar, has proved a setback, especially for traditionally high-volatility currencies like the real."

"The fundamentals remain solid, and we are not inclined to see this as a long-term turning point. But nor do we see any reason for an immediate reversal," he said.

Morgan Stanley on Monday removed its bullish call on emerging currencies, noting U.S. yields may have bottomed out.

Lifted by an anticipated surge in government spending and economic rebound following the Democrats' electoral victories, U.S. bond yields have spiked higher. The 2s-10s year yield curve on Monday hit its steepest since July 2017 at 99 basis points.

This makes the dollar more attractive to investors than more risky and volatile currencies like the real, even though they may offer higher rates of return.

These attractive yields, boosted by expectations that Brazil's economy will grow by up to 4% this year and the central bank will soon start tightening policy, had drawn investors into the real.

Commodity Futures Trading Commission data released on Friday for the week to Jan. 5 showed funds were the least pessimistic on the real since August 2019, slashing their net short position to just 3,194 contracts.

This steady reduction in bets against the real since early November coincided with it taking what looked like a potentially long-term bullish turn, when the dollar crashed below its 200-day moving average for the first time in 18 months.

A surge in global commodity prices to a six-year high, as measured by the Refinitiv commodity price index, was also seen as positive for commodity exporter Brazil.

But instead of gathering momentum and heading below 5.00 reais, which is what many analysts expect eventually this year, the dollar rebounded. It is now closer to its all-time high of 5.97 reais from last May than 5.00 reais.

The central bank sold $530 million in the spot market on Dec. 28, bringing its spot foreign exchange market intervention last year up to $24.8 billion, according to brokerage Commcor DTVM.

Despite that, the real depreciated almost 30% against the dollar last year as the central bank slashed its benchmark Selic interest rate to a record low 2.00% and a surge in public spending to tackle the COVID-19 pandemic blew a record hole in the public finances.

With fiscal pressures still lingering and the Treasury having to roll over vast sums of debt early this year, as the chart below from Societe Generale shows, domestic factors are also at play.

"The central bank should remove forward guidance and hike rates, or sell dollars. If it does neither, we'll get a continuously weaker real," said a senior trader in Sao Paulo.

(Reporting by Jamie McGeever; editing by Jonathan Oatis)