Rousseff’s Potential Response

Market participants have been bullishly greeting her slide in the polls as they try to place bets in front of any potential efforts to consolidate support and appease market interests. Rumors have been circulating for months about an impending Cabinet shake-up. In the most likely scenario, current central bank governor Alexandre Tombini is expected to take over Guido Mantega’s position of finance minister. Markets appear excited about this prospect. It’s hoped that Tombini’s recent comments about the importance of refocusing the government on its fiscal deficit would signal the administration’s willingness to restrain government largesse.

In Tombini’s place, Luiz Awazu Pereira da Silva, a well-respected deputy governor and international affairs director of Brazil’s central bank, is expected to take over the top spot at the BCB. With time running out before the election and tempers potentially rising along with temperatures this summer, markets are trying to get in front of this potentially positive catalyst. While Rousseff hopes that a change in economic leadership will help put the Brazilian economy back on track, many foreign investors are hoping that her competitors will gain additional ground leading up to October.

Outlook

At present, many currency forecasters are predicting that the real will stay range bound leading up to the World Cup on June 12. However, should the real break through the 2.20 level on the back of strengthening demand, this could signal a shift in investor psychology, resulting in a possible move to the lows we saw last October (2.15, +3.8% appreciation).6 While interest rates are only one factor in currency trading, it is worth mentioning that rates will be a full 1.75% higher than when the currency was trading at these levels in mid-October. As we mentioned in a blog post back then, we see many potential catalysts for the real to move higher, should flows into the broader emerging markets pick up steam. While volatility in the real could increase at any time, we think it offers attractive risk-reward and total return potential near current levels.

1Source: Bloomberg, as of 4/30/14
2Banco Central do Brasil in Portuguese
3Source: Bloomberg, as of 4/30/14
4Source: Reuters, as of 2/7/14
5Source: J.P. Morgan, as of 4/30/14
6Source: Bloomberg, as of 4/30/14

Important Risks Related to this Article

Foreign investing involves special risks, such as risk of loss from currency fluctuation or political or economic uncertainty. Investments in currency involve additional special risks, such as credit risk and interest rate fluctuations.

Investments in emerging, offshore or frontier markets are generally less liquid and less efficient than investments in developed markets and are subject to additional risks, such as risks of adverse governmental regulation and intervention or political developments. Investments focused in Brazil are increasing the impact of events and developments associated with the region, which can adversely affect performance.