Stars Align for Brazil’s Real to Outshine Mexican Peso in 2021

RIO DE JANEIRO, BRAZIL – Booming commodities, rock-bottom valuations and a hawkish turn at central bank are all poised to support the Brazilian real. But it’s politicians who hold the key to turning that into a long-term rally.

“Rates moving in different directions might not be enough by itself,” said Brendan McKenna, an foreign-exchange strategist at Wells Fargo in New York. “Brazil needs to shore up its fiscal position and make progress on the reform agenda for the real to gather longer-term momentum.”

After a year of splashing out on social programs during the pandemic, Brazil’s divided congress needs to rein in spending and vote in reforms to embed fiscal prudence into the yearly budgets. Without that, the real may remain becalmed no matter how strong the tailwinds, McKenna said.

The Bloomberg Commodity Index has rallied more than 30% since its April trough, lifting Brazil’s terms of trade — the ratio of export-to-import prices — to the highest since 2014. Mexico, which exports more manufactured goods, saw its terms of trade worsen in 2020 for the first time in five years.

After hitting a 16-year low in early November, the real has slowly climbed against the peso. The pair now trades around its 100-day moving average and a breakout may signal that the real has finally turned the corner.

The Brazilian currency remains the most undervalued in Latin America despite its rally since end-of-October, according to Deutsche Bank AG. The currency could approach 4.5 per dollar next quarter, an almost 15% gain from current levels, with the passage of a new budget, Deutsche Bank analysts led by Chief Economist Sebastian A. Brown wrote in a note last Friday. The Mexican peso, on the other hand, may see only moderate gains as valuations are less appealing after recent advances.

What’s more, the departure of Javier Guzman, widely regarded as the most hawkish of Mexico’s central bank board members, early next year is leading investors to double down on easing expectations. The key rate is currently 4.25%.

By contrast, Brazil’s central bank has signaled that rates will go up next year and beyond, with markets pricing in a more than doubling of the 2% benchmark Selic rate in 2021.
Brazil’s rate policy is expected to catch up with, and eventually surpass Mexico’s, by September 2021

Source: Bloomberg