Wednesday, December 03, 2008

The Brazilian

One of Macro Man's favourite themes at the moment is the necessity and likelihood of EM policy easing in response to the global recession and disinflationary/deflationary dynamic. For sure, most EM countries have eased policy to one degree or another- some of them aggressively. But a few EM CBs have stuck to their guns....for now. Therein lies opportunity. One of the best out there at the moment is Brazil.

The land of the Amazon has been a favourite target of macro punters for much of the past three years or so. Until the third quarter of this year, most of that focus was in the equity and especially the currency markets. There was little not to love about the BRL- where else could you get a currency with double-digit nominal rates, high single-digit real rates, and a current account surplus/commodity tailwind to boot?

Macro Man took a look at the BRL more than a year and a half ago and concluded (erroneously) that there was relatively little opportunity left in the currency. How wrong he was, as USD/BRL tumbled 25% in the ensuing 15 months.

Since then, of course, USD/BRL has subsequently rallied more than 50%. Was this justified? According to Macro Man's metrics, no. His favoured measure of real fair value, a terms-of-trade adjusted PPP measure, has suggested that the equilibrium level of USD/BRL has risen somewhat...but nowhere near the amount of the recent spot rally. That, Macro Man would suggest, has much more to do positioning. Sure, there were some stale foreign longs in BRL, but those surely threw in the towel by 2.00. The real story (if you'll pardon the pun) is the toxic positioning in the Brazilian corporate sector, which drove spot aggressively higher and some companies to the brink of bankruptcy. Today, onshore punters are long dollars to the tune of $13 billion, according to data from the BM&F.

While short USD/BRL will (eventually) be a nice global recovery trade, the time for it could easily be eighteen months away. No, for the time being he prefers the fixed income market, where slowing activity and a levelling off of inflation pressures have been reflected in yields with...err..exuberance.

Since the middle of November, yields across the curve have fallen more than 2% in some buckets, a very sizeable rally. The front few contracts are trading close to flat with the SELIC rate, but none are yet pricing in a cut. With industrial production virtually stagnant on a y/y basis now and indicators of global activity plumbing new depths seemingly daily, in Macro Man's view it's only a matter of time before the BCB sees the light and cuts.
That having been said, it's difficult to add/establish after a 200 bp rally, with much of it coming in thin trading conditions. It wouldn't altogether surprise to see a 50bp-plus pullback in the Jan 10- Jan 12 part of the curve.

If any sort of priced hiking is re-introduced, however, it looks like a nice opportunity. What's been especially gratifying about this trade recently is that it has exhibited zero correlation with the SPX.

Traditionally, EM fixed income trades more like a stock than a bond, rallying and falling with risk aversion. Some time last month, however, the DIs (exchange traded swaps) seemed to decide that they are, in fact, bonds, and the traditionally negative correlation between yield changes and changes in the SPX vanished.
This has made it an especially attractive trade, as it has escaped from the "risk on/risk off" mentality that has assailed most other assets in one way or another. Speaking to other macro punters recently, Macro Man has to accept that he is hardly alone in this view. But the crowd, as they say, can't always be wrong...and this is a case where fundamentals, current pricing, and thematic relevance make it one of Macro Man's favourites in an environment where equities seem to run around like a headless chicken.


Anonymous said...

Macro Man,

Spot on BRL, but may I humbly point out that shorting USD/BRL might give in was before 18-mos as you pointed out. Long USD by $12 bn will likely not make that much difference once USD deleveraging starts taking its fall come 1Q 09.

Do you see any other EM FX opportunity for the next 12-mos such as TRY, or Russian Ruble (I know call me crazy but pushing my luck here)?

Thx and best of luck.


Anonymous said...

Should be 'way before 18-mos' instead of 'was before'!

Sorry for the typo.


Anonymous said...

Good call!!, you mentioned receiving the DIs about a week ago and they have rallied tome 70 to 80 pips. We have covered the position just given how fast and how much it has moved. The other trade we like, and its a similar rationale to the DIs, is to receive Mexican TIIE swaps

Anonymous said...

congrats m-m!

buh buh buh bonds aren't really moving by sunrise out here on the left coast, must wonder when enough is enough..looks like the gross-out will be on tv talking his book

mortgages seem to have responded a bit:
fixed rate mortgage activity surged. The purchase index rose 38% and the refinance index jumped 203%..30 yr at 5.47% down from 5.98%.

Challenger layoffs were 181,671. They were 73,140 a year ago.


Anonymous said...

I just started reading your blog, very good stuff
One question when you refer to "punters" what are you describing?

Anonymous said...

Started reading your blogs a month or so ago. Awesome stuff! Thanks!

francois said...


I'm a fan of your blog which is a great way (for a non specialist like me) to gain insight into the arcane world of "global macro" . Plus , the elegant witty prose makes for a pleasant reading experience

Anonymous said...

punters refers to men who use the services of prostitutes.....or in this context risk-takers....hope this helps

Anonymous said...

anon @3:50

Aren't we all exchange our body for money one way or the other? lol

Brian said...

Does anyone know why trading in USD/BRL is virtually impossible for the non-macro managers of the world (read - the rest of us in retail land)?

I can't find a single FCM that offers this pair. HotSpot FXi doesn't carry it, nor do any of the other institutional ECNs from what I've seen. No luck on either of the Currenex hubs I trade on. Suggestions?

Vladimir said...

Hi Macro Man,

I am an economist in Brazil and I would like to add some thoughts on your view about monetary policy here.
While your call was spot on and I agree that eventualy the BCB will "see the light", I think that there are some issues at play that may prevent this from happening on the short term.
First of all there is the issue of the pass-throguh of the currency depreciation. Here in Brazil the IPCA (CPI) does not adopt the idea of "owners equivalent rent", so the weight of tradebles goods is much higher. Add to that the fact that services represents a smaller part of the household budget and also the fact that there is a history of inflation, inertia and lack of credibility. So, the impact of the sharp devaluation over inflation is no to be dismissed. Most economists see a pass-through coeficient from 8% to 10%.
Another thing that goes against the idea of an interest rate cut on the short term is the disagreement between the Central Bank and the Economic Minister. The later is talking a lot about stimulus and is likely to promote some easing of the fiscal policy in 2009. The primary surplus target, for example, was lowered to 3,8% of GDP, from 4,3% in 2008. The Central Bank will take this in cosideration when deciding about the monetary policy.
Because of these things I expect that the Selic will be kept unchanged at least until the second quarter of 2009.

I realy enjoy your blog. Keep up the good work.

Macro Man said...

Vladimir, that the lowest rates across the DI curve are trading flat to slightly below the SELIC rate (yet above the CDI rate) indicate that the market is not yet prepared to countenance immediate rate cuts. Yet there is nothing to prevent the Jan 10 or Jan 12 from trading substantially lower in short order, given that any cuts starting in Q2 will render those positions profitable if they are held to maturity.

Rob said...


I was reading your article on the Brazilian real, and felt like I should write you a note.

I am an American living in Brazil and I feel that I have been very fortunate. Just slightly ahead of the curve. Because of the retarded American monetary policy, I sold all of my stocks in May 2008. Then in July 2008, I analyzed the balance sheets of all my banks and moved funds to banks with strong balance sheets. (eg little to no mortgage risk.)

In September and December, I moved substantial amounts of money from the US to Brazil. Now, I am all cash, and about 1/2 of my cash is sitting in savings in Brazil. The savings account yields slightly over 1% per month. I am happy now because my money is earning well in Brazil. In the US it is a mess. Your choices are to get 1%/year or put it in the stock market which in my opinion is sure to go down in the next few years.

But that is not the reason that I am writing you. I feel I am fortunate because I can move funds easily out of the United States. I have had many friends ask me to buy Brazilian reals with their American dollars. This does not make sense to me. Brazil has the highest interest rates in the world. And on top of that, the dollar is at a 3 year high against the real right now. Why are not funds flowing naturally out of the United States and into Brazil?

I did some research (that's how I found your article), and it seems that it is easy to trade only in certain currencies (the US dollar, the Euro, the British Pound, Canadian dollar, Japanese Yen, and some others). However, when you analyze the countries that have the highest interest rates (Brazil, Russia, India, and China), it is very difficult to buy these currencies? The reason that I am writing is that perhaps you can help me understand why it is so hard?

My friends want to buy BRL because they have planned future expenses in the currency and they want to take advantage of the high interest rates. Heck, they are not even interested in the interest! Surely these must be some way for people to arbitrage this situation.

I also have been analyzing the financial crisis, perhaps not as well as you, and you can see some of my analysis on my blog. I come to many of the same conclusions as you regarding the American auto and financial bailouts.