Brazil Real is Rich, Might Get Richer

Brazil is getting ready to play its first World Cup game and the real is trading firmly.  For the last three days, the dollar has been flirting with its 100-day moving average, just above BRL1.80.  Today’s break below that  looks, well, for real.

The fundamental story looks fairly solid.  The economy is enjoying robust growth, which by most accounts is probably above trend.  It is one of the few countries to have recouped the output lost to the global crisis.   The central bank has hiked rates twice by a combined 150 bp and more hikes are expected.

On the capital flow side, there are three significant sources of demand.  First, foreign investors, especially from Japan, continue to be drawn to the relatively high yield.  Second are domestic entities.  Several large Brazilian businesses,including Petrobras and a couple of banks, will be selling shares or bonds abroad.  Petrobras offering is particularly noteworthy.  It is expected to raise between $50-$60 bln in a share offering in late July or August.  Foreign investors could take down a third to half of this and that translates into fairly strong demand for BRL.

Another source of domestic-based demand comes form Brazilian corporates themselves.  Some estimates suggest that Brazilian companies may be sitting on $15-$20 bln of foreign earnings that will repatriated at some juncture. Brazilian officials have tried to discourage BRL strength with various measures including a tax on foreign fixed income investors and ADRs, and nearly daily dollar purchases.

However, with the central bank in a tightening mode, there is a suspicion that officials may show a little more willingness to accept a gradually firmer real.  With the BRL1.80 level giving way today, the next target is near BRL1.77 and then BRL.175.   The BRL1.70 area is likely to be more formidable support for the US dollar.