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Brazilian Real Gets Hammered

Stocks in this article: TK

By Win Thin

The Brazilian currency, the real, is getting hammered today and is one of the worst performers in the current risk-off environment.

The dollar/real currency pair (USD/BRL) is approaching the key 1.90 area, which is the high from January and again in May. Given the heightened level of concern regarding Europe/Greece, this level may not hold again.

A break of 1.90 would point to a test of the minimal retracement level for USD/BRL at 1.9850, which is the 38% level of the big drop in 2009 as risk appetite picked up.

Although emerging-market fundamentals remain strong, we cannot foresee any sustainable emerging-market foreign exchange rally until the situation in Europe has been addressed.

High interest rates are no protection, as the Brazilian real (with rates at 9.5%) is suffering more today than the Czech koruna (CZK) (0.75%) and Polish zloty (PLN) (3.5%).

We do note, however, that Brazil interest rate futures have pared back tightening expectations as the European crisis deepens. The January contract has fallen to 10.97% from a peak of 11.23% in early May, and it may fall further. This has occurred despite upgraded growth forecasts and a continued creep higher in inflation (mid-May IPCA rose a larger-than-expected 0.63% month over month and boosted the year-over-year rate to 5.26%).

Other emerging-market currencies have broken or are about to break some notable levels. The dollar/Mexican peso pair is back to more than 13, the dollar/rand pair (USD/ZAR) is flirting with 8.0 and the dollar/Chilean peso pair (USD/CLP) is back to more than 550.

Equities are down significantly, commodities are falling and Treasuries are up. Thus, the classic risk-off trade is in play. Although the euro has held up after yesterday's short-covering rally, it should eventually play catch-up. After all, Europe is the epicenter of all the sovereign risks that are roiling the markets right now, so it cannot escape today's carnage for much longer.

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