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Is Intervention a Real Relief for Brazil ETFs?

Zacks Equity Research

Brazilian economy, one of the BRIC majors and the biggest economy in South America, has been suffering from severe structural problems including slowing growth, rising inflation (6.27% in July 2013) and widespread socio-political issues for quite sometime.

While these alone pose tremendous concern, the real pain has cropped up in the country’s currency market. The performance of the Brazilian currency – Real – has been downright painful for quite some time (read: Short Brazil with These Inverse ETFs).

Inside the Real Weakness

The real already saw its biggest drop against the dollar in more than four years in early July and is now approaching its five-year low against the dollar. Quite expectedly, Brazilian real can now be be called the emerging markets’ worst performing currencies against the U.S. dollar
depreciating more than 17% in the first half of the year.
According to Reuters, the latest reason for the plunge in emerging market currencies is the possible tapering of the Fed’s bond buying program which has led to the strengthening of the US dollar,  and caused a spike in U.S. debt yields, thereby pushing up borrowing costs globally. Emerging markets have to depend on cheap capital to finance their huge current account shortfall. Consequently, these markets were hurt by the reversal in capital flows, resulting in shap decline in their currencies and stock markets.

As per tradingeconomics, Brazil recorded a trade deficit of $3,953 million in June 2013 while it recorded the worst deficit level (between 1980 and so far in 2013) only a few months ago – in January this year. In such an import-centric scenario, an extremely weak currency is sure to take a toll. Given its large current-account deficit, Brazil now needs to magnetize sizeable inflows just to keep the real alive.

Central Bank Intervention

Continued fall in the real will make imports costlier and in turn aggravate the country’s inflation. On August 22, Brazilian central bank intervened in the currency market to provide $60 billion worth of cash and insurance by the year end to spark the real’s prospect and augment liquidity. The measure is intended to serve triple targets of taming inflation, arresting the real from further slide and setting growth in motion. This currency intervention is likely to widen Brazil’s $45 billion strategy  adopted earlier in 2013.

Brazilian Central bank has raised the Selic rate thrice so far this year to curb inflation as well as strengthen currency, but this in turn was hurting the country’s growth profile. Brazil recorded 0.9% GDP growth last year, after registering 2.7% growth in 2011 and 7.5% in 2010.

Following the announcement, the real registered its biggest gain in almost two years, advancing 3.7% to 2.3488 per dollar (on August 23) and suggesting that the problem might take a breather in the near term.

ETF Impact

WisdomTree Brazilian Real Fund (BZF) – The only fund designed to deliver returns corresponding to the money market rates in Brazil and appreciation of the Brazilian Real relative to USD, plunged about 9.7% on August 23, but gained about 3.28% after the Central Bank’s intervention. This fund provides exposure to the movements of the Brazilian real against the U.S. dollar. This ETF – charging 45 basis points a year – is not a very liquid one.

Year-to-date, this product has lost around 10% thanks to reduced demand for high-yielding but risky emerging markets currencies as well as the sagging Brazilian economy. The product is presently performing better ($16.98 as of August 23) than its 52-week low level of $16.33 indicating that currency recovery still has a long way to go. The product BZF currently has a Zacks ETF Rank of 3 or ‘Hold’.

If we look at the Brazilian stock market, the performance is even worse with ultra popular iShares MSCI Brazil (Free) Index Fund (EWZ), Market Vectors Brazil Small-Cap ETF (BRF) and iShares MSCI Brazil Small Cap Index Fund (EWZS) all plunging double digits in the year-to-date timeframe, indicating further pains for the country (read: The Comprehensive Guide to Brazil ETFs). The funds EWZ, BRF and EWZS were beaten by a respective 21.7%, 28.8% and 28.1%.

Bottom Line
A lot has been talked about currency woes lately across most of the emerging nations with Brazil, India, Indonesia and Turkey leading the list (read: 3 Currency ETFs Crushed in Emerging Market Rout).
Brazil is not the only country where policy makers are trying and testing measures to stabilize currencies, the remaining three are also resorting to various initiatives. Among these, rate hike in Turkey and increased import taxes on luxury goods in Indonesia are to name a few. But these measures are yet to show any constructive results (read: Turkey ETF Tumbles on Surprise Rate Hike).

Given this, Brazilian central bank’s effort to put such a large volume of cash behind its sinking currency came as a pleasant surprise. And even if the improving momentum doesn’t hold well over the longer term as the underlying causes of concerns remain intact, investors should note that the step might bring only a short-term respite (read: Brazil ETFs Surge, But Can It Last?).

The measure “should eliminate some of the uncertainty, and help the [real] trade closer to its peers, but we don’t believe it changes the weakening trend of currency” said Marcelo Salmon, Barclays co-head of Latin America economics and strategy.
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