The Incredible Shrinking Short Sale That's Fueling Brazil Rally

  • Bearish bets against Brazil's real at lowest in over 2 years
  • Wagers decline to $15 billion from $39 billion in May 2015

The currency market is becoming more convinced that the Brazilian real’s world-beating rally this year is far from over.

Foreign investors have reduced their bearish bets against the currency in the futures market by 33 percent since the end of 2015 to $15 billion, the least since November 2013, according to data compiled by Bloomberg and BM&FBovespa SA, Latin America’s largest exchange. The wagers had swelled to a record $39 billion in May 2015.

Brazil bears and most forecasters were caught off-guard by the real’s 10 percent appreciation in the first quarter, which was fueled by optimism that the impeachment of President Dilma Rousseff will usher in a new government better equipped to kick-start growth in Latin America’s biggest economy and cut spending. A further unwinding may add fresh support for the real, complicating Central Bank efforts to slow the rally.

“It’s expensive to bet against the real,” Paulo Nepomuceno, a fixed-income strategist at brokerage Coinvalores CCVM in Sao Paulo, said in a phone interview. “The political scenario is improving here. A credibility shock could bring foreign money back to Brazil."

Currency Forecasts

It costs short sellers about 11 percent a year to keep their bearish position, based on implied yields in forwards. The real would need to weaken by more than that to make it a winning bet. That’s becoming more of a long shot after foreigners injected $4 billion into the economy this month through April 15. It follows foreign-exchange outflows, including trade and investment, of a combined $12 billion in the previous two months, according to the central bank.

This year, the real has gained 12 percent, reaching an eight-month high of 3.4607 per dollar on April 14. The momentum has slowed over the last month as the central bank resumed sales of reverse currency swaps, the equivalent of buying dollars in the futures market.

The currency gained 0.5 percent to 3.5475 per dollar as of 3:56 p.m. in New York. While analysts surveyed by Bloomberg still look for the real to weaken about 10 percent to end the year at 3.93 per dollar, they’ve revised up their median forecasts from 4.3 per dollar at the end of February.

Brazil’s lower house voted in favor of ousting Rousseff on April 17, sending the impeachment process to the Senate and opening the door for Vice President Michel Temer to take power. While Temer’s own party is ensnared in the same sweeping corruption scandal that has undermined Rousseff’s support, he’s likely to win back investor confidence by putting together a credible economic team that may include former Central Bank Governor Henrique Meirelles, political consultant Eurasia Group said in a report on April 20.

“There’s still room for small rallies,” said Joao Pedro Ribeiro, a strategist at Nomura Holdings Inc. in New York.

For strategists at Citigroup Inc., global factors including commodities and risk appetite are likely to play a bigger role now that the domestic political turmoil has largely been priced in. With an economic recovery in China and a dovish Federal Reserve, the real remains attractive because of the nation’s interest rates, strategists Kenneth Lam and Dirk Willer wrote in a note on Thursday. They recommend that clients bet the real will advance via options.

“Going forward, I think this short position should only fall further if and when the impeachment of Rousseff actually occurs,” said Leonardo Monoli, a Sao Paulo-based partner at Jive Asset Gestao de Recursos, which is the biggest independent buyer of distressed assets in Brazil. “For sure, the reduction or increase of this position will influence the price of the currency.”

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