Forex Investment and Currency Trading

BRL: best positioned for the global shock to risk appetite
Traders expect BRL to strengthen for the year as a whole, boosted by an improvement of the global risk appetite in the last quarter. Beforehand, persisting global financial market uncertainty should maintain BRL’s performance broadly flat, highlighting the currency’s resilience to a challenging risk environment. BRL will outperform its peers in the context of a shock to risk appetite, a long BRL-MXN position is recommended.

Brazil’s balance of payments position had warranted a weaker BRL, but the currency is oversold at these levels. The economic slowdown and the weaker currency should slow the trend deterioration in the current account. The volatility of recent months has discouraged long-term investment decisions with USD futures data and risk reversals suggestive of defensive positioning. Improved global risk appetite toward the end of the year should encourage renewed financial inflows given the attractive carry. BACEN’s sizeable FX reserves and commitment to intervention should also help contain the risk of sharp sell-off for the BRL.

MXN: a late but strong recovery
USD-MXN should remain in the 14.50 range over the next six months, with risks skewed to the upside during the period, but market would expect a strong MXN rebound toward the end of the year as the global risk appetite improves. The US recession will lead to a deterioration of Mexico’s balance of payments given
reduced export demand and a slowdown in remittance inflows, and is therefore expected to weigh somewhat on MXN performance.

Banxico has sold USD16.8bn since October 2008 in an attempt to curb MXN weakness, including USD1.06bn in discretionary intervention earlier this month, but USD-MXN nonetheless continues to grind higher. Current FX reserves of USD82.1bn are unlikely to be sufficient to stop USD-MXN from pushing higher amid a renewed bout of risk aversion and deteriorating investor sentiment. The yield differential against the USD remains attractive, but will become less so in 2009. Some economists expect Banxico to cut the policy rate by 150bp. This would normally boost appetite for local fixed income exposure, but FX volatility may discourage some capital inflows. By year-end, the unwinding of the oil revenue FX hedging should provide strong support to the currency, however.