Don't Be Fooled by Brazil Calm as Real Still Forecast to Slump

  • Volatility drops most in world after jumping to four-year high
  • Analysts see currency weakening to 4 per dollar by end of 2015

Wall Street strategists are warning clients not to be fooled by the sudden calm that’s fallen upon the Brazilian real.

A measure of its volatility has fallen the most among the world’s major currencies in the past month after reaching a four-year high in September. Price swings are abating as calls for President Dilma Rousseff’s impeachment ebb, lessening concern about political chaos in Brazil.

Yet analysts say this optimism is overdone and that the momentary calm doesn’t change a long-term outlook that includes a potential credit-rating downgrade and a deeper recession. The worst-performing major currency in 2015 will continue to weaken by the end of this year and won’t rebound before 2019, according to median forecasts in Bloomberg surveys.

“The real looks expensive,” Christian Lawrence, a currency strategist at Rabobank, said from New York. The currency closed at 3.8494 per dollar Friday, after rebounding from a record low of 4.2478 on Sept. 24. “It should be north of 4 per dollar. Economic deterioration and a downgrade are seen as base cases for me.”

The real rose 0.8 percent to 3.8198 per dollar on Monday.

It has tumbled 31 percent this year as Latin America’s largest economy heads toward the longest contraction since the 1930s amid accelerating inflation and a widening graft scandal. Rousseff’s record disapproval rating has heightened opposition in Congress to belt-tightening measures such as tax increases and spending reductions. With the government struggling to shore up the budget, the nation’s credit rating suffered four downgrades since 2014, including a cut to junk by Standard & Poor’s this September.

It’s highly likely Brazil’s credit rating will be lowered again in the next few months unless there’s an improvement in the political outlook, according to Bernd Berg, director of emerging-market strategy at Societe Generale SA. With no progress likely, the currency could drop to 4.4 per dollar, becoming cheap again, he said.

"I expect problems to intensify in Brazil, with weaker growth and higher inflation toward the end of the year,” Berg said. “And I expect no improvement in the political stalemate.”

Speculation that Finance Minister Joaquim Levy could be swapped at the start of next year for former central bank chief Henrique Meirelles, who presided over faster growth and slower inflation, has fueled the recent rally in the real. The assumption is he has more political strength to win approval for fiscal-austerity bills that have stalled in Congress.

“The situation is stuck right now as the market sees the smallest move as a hope,” said Ipek Ozkardeskaya, an analyst at London Capital Group in London, who sees the real at 4 per dollar by the end of 2015. “Considering Rousseff names Meirelles, it could mean better political support, and would help pushing reforms through the wire with less resistance.”

As a result of those bets, many traders have turned less bearish on the real. The currency’s three-month implied volatility versus the dollar slumped 3.5 percentage points in the past month to 20.5 percent. The 25-delta risk-reversal, a measure of the premium for the right to sell reais over the right to buy the currency, was at 3.02 percentage points on Monday, down from a more than three-year high of 5.03 percentage points last month, based on end-of-day prices compiled by Bloomberg.

Yet analysts aren’t convinced the outlook will improve so soon. They project the real will end the year at 4 per dollar, and continue around that level in 2016 and 2017. They predict a drop to 4.18 by the end of 2018 before a rebound the following year.

“The recent gains in the real were basically of people trying to take advantage of the scenario in which we saw less negative headlines,” said Jefferson Rugik, a currency trader at brokerage Correparti Corretora de Cambio in Curitiba, Brazil. “That’s not necessarily the trend going forward. The only thing we know is that there are expectations for the currency to get weaker, because things are not improving at all.”

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