By Simon Smith Chief Economist at FxPro
By Simon Smith Chief Economist at FxPro

Brazil – the year ahead

Last time, I looked at the impact of events in China on LATAM currencies, but as we enter a new year and a likely Fed tightening, it's worth taking a step back and a look at what the coming year may hold.

First Published: e-Forex Magazine 63 / Currency Clips / January, 2016

Last time, I looked at the impact of events in China on LATAM currencies, but as we enter a new year and a likely Fed tightening, it’s worth taking a step back and a look at what the coming year may hold.   There are two things to know about the impending Fed tightening.  Firstly, it’s the most trailed and anticipated tightening move by any central bank in modern history.  The market has been pricing it at the beginning of each of the past four years but it has never materialised.  Secondly, its impact on emerging markets has also been the most profound of any tightening.  Recall the so-called ‘taper tantrum’ of 2013, when the Fed had to do loads of ground work as emerging markets wobbled just at the thought of coming off the drip-feed of Fed quantitative easing. 

Brazil – the year ahead

As always with EM, one has to distinguish between the systematic and non-systematic influences.  To what extent is any particular currency or country being influenced by the pressure on the asset class in general, or the country specifics?  I touched on the Chilean Peso last time, carrying on my words of caution from June.  This time, it’s worth thinking about Brazil, where the problems the country is facing are fairly clear. 

Firstly, growth is likely to remain weak next year; indeed another year of contraction is on the cards, coupled with above target inflation and a central bank chasing its tail to try and keep on top of it.  This is never a comfortable combination for a currency, even with the carry available with rates above 14%.  The second factor is the balance of growth, with investment still lacking in infrastructure, in stark contrast to what we’ve seen in China in recent years.  There are also fiscal risks, as the government finances tumble further into deficit on the back of the contracting economy.  

On top of this, there is the global backdrop, which has not been kind to emerging market currencies over the past 2.5 years.  Those less favoured have been those more reliant on dollar financing, running twin deficits and more reliant on short-term financing.  This means that we could easily see USDBRL push to the 4.50 level before any signs of stability start to come through.  Many think the worst is over for EM and that will be true for some in 2015, but it won’t include Brazil.