BRL: Revising FX rate down to 3.30 for end-2018 – Rabobank

Mauricio Oreng, Senior Brazil Strategist at Rabobank, suggests that according to their calculations, global factors (such as EM credit spreads, commodity prices) have been the main drivers for the BRL strength over the last couple of years, accounting for 56% of the 77-cent appreciation versus the USD since late 2015.

Key Quotes

“Domestic drivers account for 38% of that movement (the 6% left is a residual). This estimate mirrors an international backdrop of faster growth and easy money, as well as the positive local developments in economic policy, external position and activity recovery.”

“Given such a favorable global backdrop, we have revised down our USD/BRL projection for the end of this year to 3.30/USD (from 3.40/USD). According to our models, an expected (appreciating effect of the) gain in commodity prices would offset the (depreciating effect of a) possible widening in EM credit spreads. Expectations about domestic fundamentals will likely support the BRL, after the materialization of (our assumption of) a constructive electoral outcome when it comes to the outlook for economic reforms from 2019 onwards. Yet we are keeping a bit of “fat” (10-15 cents) in our FX projection for this year, reflecting the risk (and respective probabilities) of less favorable global liquidity conditions or less constructive domestic outcomes in 18H2.”

“Our (stress) simulations show that the potential BRL impact from domestic uncertainties (i.e. elections, reforms) outdo the potential impact from (reasonable) global scenarios. We see risks widely asymmetrical, with a lot more upside (i.e. weaker FX rate) than otherwise, as we see markets already pricing in high probability of good local developments.”

“Given the possibility of ambiguous FX impulses from external drivers (e.g. higher commodity prices versus higher global interest rate, wider EM credit spreads), we see the level of 3.00 as a possible floor (i.e. best-case scenario) for the Brazilian FX rate this year.”

“The worst-case scenario is an adverse political development (when it comes to the outlook for economic reforms in 2019-2020), compounded with an eventual deterioration in the global scene – either in terms of policy normalization/liquidity or in terms of growth/risk appetite. In these scenarios, USD/BRL could well jump towards 4.30-4.50.”

“We consider a range between 3.10-3.40 as reasonable for the FX rate by the end of 2018. As far as our point-forecast (3.30) go, we still see more downside than upside.”