Forex Investment and Currency Trading

1 – 3 Month Outlook: BRL at mercy of credit crunch

• The merger of ITAU and UNIBANCO over the weekend may drive another bout of USD/BRL buying, offsetting the positive news of Brazil’s inclusion into the Fed’s swap line arrangement
  and the new-IMF preferential access financing (the Short-Term Liquidity Facility, SLF) last week. With the possibility of other smaller banks suffering due to the liquidity squeeze, the odds of a BCB rate hike have completely evaporated. Going forward, the BCB will likely prioritize providing liquidity to local corporates and financial markets. The combination of US$200bn of FX reserves, and access to the SLF and the Fed’s swap line (which together account for another ~US$50bn), give the Brazilian government significant ammunition to provide liquidity to the local banking sector in order to contain any systemic breakdown.

6 - 12 Month Outlook: Global slowdown leads BRL lower

• The BRL should continue to trend-weaken as lower commodity prices and weaker investment flows combine with slower global growth. Additionally, domestic investment will slow as exports, commodity prices, and domestic lending all recede. With slower growth prospects, market expect the currency’s depreciating trend to remain in place, at least for another 12 months. Market looks for USD/BRL at 2.2 by year-end 2009, but the risks are tilted towards additional BRL weakness given negative momentum for the global-growth/risk-appetite outlook. Strong evidence of the weaker growth outlook is evident in corporate capex program revisions, which are pairing down investment and output due to slowing demand,
  both foreign and domestic.
• On a positive note, the BCB has significant liquidity available to support the economy and avoid a disorderly adjustment. The government has been proactive in providing liquidity to the
  banking and corporate sectors in order to avoid the credit crunch turning into a solvency issue. This risk is highlighted by the merger of the country’s second and third largest banks over the weekend. It is possible that corporate/bank loss announcements will continue going forward, due to both FX moves and liquidity shortages. Still, the Brazilian banking sector remains well capitalized relative to most EMs, and the government has significant resources to support it.