Currency of the Month – Brazil Grinds to the Finish Line

One would think with opening ceremonies for the Rio 2016 Olympic Games no less than two months away, the news coverage in Brazil would be about final touches on competitive venues, mounting athlete enthusiasm or tender human-interest stories following the Olympic torch relay. Instead, coverage in Brazil seems to be a magnet for bad luck, with the media focused squarely on negative stories describing sewage-filled aquatic venues, presidential impeachments and Zika virus fears, not to mention the recent executive order by the governor of Rio de Janeiro declaring a financial state of emergency for the State.1

Perhaps even more mystifying is that despite this barrage of negative coverage, the Brazilian real has been one of the top performing currencies in 2016 for the year-to-date period, increasing 14% since the beginning of the year.2 Admittedly, the Brazilian real is rebounding off an extended period of decline since 2011 relative to the U.S. dollar, but the real’s performance this year in the face of such negative coverage would seem to indicate that the Brazilian economy may be finding a “second-wind” as it grinds through the last few miles of the marathon (Figure #1).

Fig. #1
BRL/USD Historical Exchange Rate
(June 2006 – June 2016)



Long-time readers of the Daily Pfennig® newsletter may recall our less-than-optimistic analysis of the Brazilian real in the Sept. 6, 2015, edition (“An Uphill Marathon Awaits for the Brazilian Real”), which cited global economic challenges, commodity price declines, domestic financial pressures, political instability and deteriorating financial internals as reasons to be cautious with investments in the real. Nine months later, the economic fundamentals have not changed materially, with gross domestic production estimates remaining in contraction mode (Figure #2). However, the tides may have started turning for the Brazilian economy and the real.

Fig. #2
Brazil Annual GDP Growth
(2005 – 2017 Estimates)

Source: The WorldBank, GDP Growth (annual %) – Brazil, 2001-2015; Global Economic Prospects – Brazil, 2013-2018f (data as of June 20, 2016)


Factors Driving the Brazilian Real
Any number of factors can be attributed to explaining the Brazilian real’s relative strength thus far this year. The country’s political instability has been partially resolved, in a sense, as former President Dilma Rousseff’s recent suspension and pending impeachment trial has ostensibly diminished the country’s political stagnation due to persistent controversies surrounding the left-wing Worker’s Party, including budgeting law violations to source social program spending, corruption and money laundering charges, high inflation, and stagnant economic performance.3

Interim President Michel Temer of the Brazilian Democratic Movement party has temporarily replaced the widely unpopular Rouseff, leveraging his center-right leaning platform in promoting stimulus policies to return the Brazilian economy to growth.4 Analogous to reforms currently underway in the country’s southernmost neighbor, Argentina, Brazil’s interim president has proposed cuts to public spending, pension reforms, government employee job cuts, removing protectionist trade policies, tax system reforms and fiscal deficit reduction initiatives in order to reign-in inflation, stabilize debt and return Brazil to low single-digit economic growth.5

Since 2013, the Brazilian Central Bank has aggressively raised short-term interest rates, known as the “Selic Rate” in order to address the economy’s increasing rates of inflation (Figure #3). Inflation rates in Brazil have remained persistently above the central bank’s target of 4.5% since 2009, sparking a concentrated effort to raise short-term interest rates from a low of 7.25% in September 2013 to the most recent Selic rate of 14.25%.6 After inflation peaked at 10.7% in January 2016, the CPI level has more recently settled to 9.3% in May 20167, indicating that the central bank’s tightening efforts have started to generate positive returns. As inflation rates fall, the Selic rate will most likely drop, as well, offering investors a current opportunity to lock in high rate differentials relative to the U.S. dollar, yen, or euro prior to the Selic rate returning to more normalized levels.

Fig. #3
Selic Target Interest Rate
(July 2006 – July 2016)

Source: Central Bank of Brazil Statistical Database


One of the more fashionable theories explaining the recent boost to the Brazilian real is the upcoming Olympic Games in Rio attracting investment capital and interest in the currency. While economic studies on the performance of an Olympic host’s currency performance during the months leading to the start of the games is admittedly limited, empirical evidence over the past six games appear to at least add some credence to the theory. In the months leading up to the 1992 Olympics in Spain the euro saw a boost of more than 10% relative to the U.S. dollar. The Australian Olympic Games in 2000 increased that currency by nearly 8%. Greece saw a lift of nearly 5% in 2004, while China’s renminbi increased by nearly 3% in 2008. The euro gained nearly 6% leading up to the Olympic Games in Britain in 2012.8 However, as we mentioned in our September 2015 article on the Brazilian real, these gains tend to be transitory and short-lived.

Outlook for the Brazilian Real
The previously mentioned executive order declaring a financial crisis and state of emergency within the State of Rio de Janeiro just 50 days before the start of the Olympics is a good illustration of the fundamental troubles facing the Brazilian economy as a whole, and by extension, the Brazilian real. The order cites “severe difficulties in the provision of essential public services,” potentially “causing a breakdown in public security, health, education, mobility and environmental management.”9 While the order is clearly designed to legally divert cash to support the Olympic games, these issues are systemic to the Brazilian economy: excessive government mandated social spending, absence of growth and infrastructure failures, particularly within the commodity sector.

The Brazilian economy continues to suffer from the same issues plaguing the country one year ago. Problems include weakness in the commodity complex, slowing growth from the country’s key trading partners in the European Union and China, high levels of debt and constitutionally mandated, non-discretionary spending for necessary governmental services, such as social benefits, entitlements and infrastructure, which represent 90% of the country’s budget.10 That said, there now appear to be more reasons for optimism with respect to the economy, given the interim government’s strategy for reducing restrictive trading regulations, reducing social program spending, eliminating government waste and containing inflation rates. Export activity has already seemed to improve since the interim government has taken control, providing more evidence as to the restrictive trading policies during Rouseff’s party. The Brazilian economy will further benefit from higher oil pricing, and if government efforts are successful in generating growth, the currency would certainly benefit.

Nevertheless, the outlook for the Brazilian economy and the real remain murky, at best. Depending on the outcome of Rouseff’s impeachment trial, the country may continue to be plagued by political instability for the next six to twelve months. Moreover, the theoretical boost the Brazilian real may have received from the pending Olympics could certainly fade once the athletes pack their bags at the end of the summer. As such, short-term caution for investments in the real remains warranted, keeping an eye open toward future developments in the political environment and any progress toward sustainable growth.

Until the next Daily Pfennig® edition…

Chuck Butler
Managing Director
EverBank Global Markets Group