FX Market’s ‘Least Favored Country’ of Brazil May Recover

The Brazilian real hit a new all-time low on Tuesday after authorities announced a massive austerity package at a time when the economy is shrinking fast.

But unlike those euro zone countries that faced similar economic and political straits following the sovereign debt crisis, Brazil’s control of its own currency may help it find a way out.

“Really Brazil is in a hole and it’s a deep hole and it is going to take many years to get out of that hole. But the situation is quite different to that of Europe,” Neil Shearing, chief emerging markets economist at Capital Economics, told CNBC early on Tuesday.

Since the U.S. Federal Reserve’s high-profile decision to hold interest rates last week, most emerging market and major currencies have outperformed against the U.S. dollar. The real—together with the Indonesian rupiah—is an exception, with the Brazilian currency reaching a record low of more than 3.99 against the greenback on Monday, before topping 4.03 on Tuesday. It has fallen by more than 25 percent against the dollar since mid-June, leading Kit Juckes, macro strategist at Societe Generale, to term it “the FX market’s least favored country” in a research note on Tuesday.

In addition, Brazilian five-year credit default swaps (CDS) posted one of Monday’s worst performances among sovereigns, widening by 31 basis points or 7.9 percent to 426. Widening CDS spreads suggest a rising perception among investors that an entity may default on its debt.

This came after last week’s unveiling in Brazil of a $17 billion austerity package for 2016, aimed at plugging a gaping budget hole and restoring investors’ depleted confidence in the government. The measures are divided between tax hikes and spending cuts and will likely further knock the popularity of President Dilma Rousseff, who is already facing impeachment calls in relation to a massive corruption scandal.

Meanwhile, the Brazilian economy is shrinking and inflation remains high—a toxic combination known as a “stagflation” that the U.K. suffered in the 1970s. Barclays Research forecasts a sharp 3.2 percent economic contraction in Brazil across 2015 as a whole, with a 1.4 percent quarter-on-quarter seasonally adjusted slump expected in the third quarter. The bank is downbeat for next year as well, forecasting a 1.5 percent contraction in 2016.

Inflation figures published on Tuesday showed trailing 12-month inflation of 9.57 percent, which is more than double the government’s 4.5 percent target.

CNBC

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