Movement helps explain shift in expectations for the real’s performance
05/14/2024
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Fabio Landi — Foto: Leo Pinheiro/Valor
Investor hopes for a stronger Brazilian real at the turn of the year quickly dissipated. The robustness of Brazil’s trade balance bolstered renewed expectations for the real’s appreciation, similar to last year, when the commercial flow was solid. However, a significant outflow of dollars through the financial account dashed these expectations.
In the first four months of the year, Brazil saw the second worst financial flow since the official records began in 1982—a net outflow of $20.8 billion—second only to 2020, which helps to explain the change in expectations for the real’s performance.
“The contracted exchange rate at the start of this year is much worse than in the same period last year, and the main culprit is the financial flow,” said Ronie Germiniani, head of Itaú BBA’s exchange desk. “The trade balance, on the other hand, is in line with what we saw in 2023, with even better numbers, as expected.”
While the financial flow was negative by $20.8 billion in the first four months, the trade balance showed the opposite movement: it recorded the second-largest dollar inflow since official records began between January and April, totaling $27.6 billion.
The mismatch between the commercial and financial flows frustrated many Brazilian investors. Focusing mainly on the influx of dollars from exports, some managers began to bet on the real’s appreciation, anticipating some easing of U.S. monetary policy. For example, Verde Asset bet on the real against the dollar in November last year, citing a “structural improvement” in the trade balance.
Like Verde, other local asset managers started to view the commercial flow as a key factor for the real’s appreciation. From May 2023 to the end of January this year, local institutional investors’ bets on the Brazilian currency’s appreciation through the derivatives market increased to $17.5 billion from around $4.7 billion, according to data from B3.
Fabio Landi, a partner at Adam Capital, recalls that at the turn of the year, “the entire market” calculated the trade balance with the rise in exports and began to work with the expectation of the real’s appreciation. “The short position in dollars and long in real became consensus, partly due to the perception that the U.S. Federal Reserve would reduce interest rates, leading to a weaker dollar against all currencies; Brazil still had a positive carry, and the balance of payments was strong, meaning all factors pointed towards a real appreciation.”
The local market correctly anticipated a strong trade balance, which would translate eventually into a robust commercial flow. However, the surprise on the financial account was much more negative than agents had expected.
Adam Capital started the year with long positions in the real but began to switch to short positions (betting on depreciation) by the end of February. “We never believed in a weak U.S. economy. Despite [Fed Chair Jerome] Powell’s political will to cut rates, we didn’t think the data would be sufficient to warrant a rate cut. This scenario was delayed, and the market realized we were in a high U.S. interest rate environment with a strong dollar. Consequently, the idiosyncratic factors of each country became secondary,” said Mr. Landi.
Mr. Germiniani of Itaú also emphasized the importance of the Fed’s decisions for the global market, noting their significant impact on the Brazilian stock exchange’s performance. “While it’s challenging to pinpoint the exact reason for the entire outflow through the financial account, one easily traceable factor is the foreign exit from the stock market,” said Mr. Germiniani. “We’ve seen between $6.5 billion and $7 billion in foreign capital outflows from the stock market this year, which is very significant, accounting for about a third of the total outflow.”
However, the Fed isn’t the only reason for this outflow. Mr. Germiniani said that with the prospect of a more conservative U.S. monetary policy and a market with lower liquidity, foreign investors become more selective and sensitive to local uncertainties. “Doubts about fiscal policy, Petrobras, and even the COPOM [the Brazilian Central Bank’s Monetary Policy Committee] scare money away from the stock market,” he said, noting that the return of this capital is also more uncertain. “When making choices, foreign investors opt not to buy assets from places where there are constant disturbances.”
While a third of the capital outflow via the financial account can be explained by disinvestment in the stock market, the explanation for the remaining two-thirds is more elusive. Luís Afonso Lima, head of analysis at Mapfre Investimentos, looks to the balance of payments for answers, “even though the numbers don’t always align.”
“There’s been a significant increase in dividend payments by foreign and Brazilian companies to overseas,” Mr. Lima said. This scenario is “curious” because although the Brazilian economy is doing well, it isn’t robust enough to generate such high profits and lead to such substantial remittances. “The explanation likely lies in the fact that much of this capital is sent by mineral extraction companies, mainly Vale and Petrobras, benefiting from commodity prices.”
Additionally, a third factor in the capital outflow through the financial account involves spending on services. “When you look in detail at the balance of payments, you notice many expenses related to transportation because conflicts in the Middle East increase freight costs; there are also higher insurance costs and services for telecommunications and computing,” said Mr. Lima. “It’s hard to say how relevant each factor is for the financial account outflow, but U.S. interest rates certainly explain a large part.”
Mr. Lima also suggests that the contracted exchange rate scenario will likely worsen before improving. “Perhaps by mid-year, as U.S. disinflation shows consistent signs, we might have more predictability regarding rate cuts in the U.S. In this case, I can see chances of improved flows to emerging markets,” he said.
For Mr. Germiniani, the mere signal of rate cuts in the U.S. isn’t enough to guarantee a reversal of the capital outflow seen earlier this year. “We can’t be overly optimistic about the stock market and the flow because the U.S. narrative remains very strong. They have high, very restrictive interest rates, and their economy is booming. Just look at the S&P 500 chart,” he said. “Even though rate cuts would benefit emerging markets, I don’t believe the recovery will be strong.”
Similarly, Mr. Landi, with Adam Capital, said, “We’re not yet at a point where we don’t have a strong dollar.” The firm continues to hold small positions in the dollar against the real. Mr. Landi said that the timing for the Fed to start cutting rates remains uncertain, and in Adam’s view, the U.S. central bank may continue to delay the start of a monetary easing cycle.
*Por Arthur Cagliari, Victor Rezende — São Paulo
Source: Valor International