MercoPress. South Atlantic News Agency

Brazilian Real rebounding strongly after months of erosion; central bank forecasted to further cut Selic rate

The Real has weakened more than its peers, with room to recover further. Over the past 12 months, its relative depreciation has been has even steeper

The Brazilian Real and Mexican peso have both rebounded strongly in recent weeks, but their rallies are starting to diverge with the peso running out of steam and the Real gaining momentum.

The two heavyweight Latin American currencies were pressured this year as their countries' central banks slashed interest rates, historically deep recessions loomed on the horizon and investors dumped emerging market assets due to the coronavirus crisis.

Now, both currencies have surfed the wave of improving global market sentiment and appetite for risky assets with trillions of dollars of monetary and fiscal stimulus lifting hopes for a quick post-pandemic economic recovery.

The peso's selloff faded earlier, and it has appreciated 15% against the U.S. dollar since mid-April. Brazil's Real hit a record low in mid-May but has rebounded more than 20%. The Real on Friday surged through 5.00 to the dollar for the first time since March, headed for its biggest weekly gain since 2008.

The Real has weakened more than its peers, with room to recover further. Over the past 12 months, its relative depreciation has been has even steeper. “It has underperformed big time and would be part of any broad dollar weakness rally,” said Alexandre Song, portfolio manager at Macro Capital in Sao Paulo.

“The laggards before are the winners now. No one is long the Real, it is widely under-owned,” he said, adding that a sustained break through 5.00 per dollar could accelerate the move.

Analysts said the erosion of the Real's yield advantage should be fully discounted by now. The Brazilian central bank is expected to cut its benchmark Selic interest rate by up to 75 basis points this month, but has indicated this will be the last cut.

That puts the Real in pole position if the assets most shunned when markets tumbled are due for a sharper rebound, as many analysts expect.

Brazil's economic and financial position is far from stellar. The economy is poised for its biggest-ever annual slump of more than 6%, according to consensus forecasts, and the government's deficit and debt will balloon to record levels.

But Brazil's US$3.5 billion dollar-bond sale this week, its first since 2019, drew huge demand from investors, suggesting foreign capital is ready to return. Central bank figures this week showed Brazil posted a net foreign exchange inflow in May of US$3.1 billion, the first inflow since July last year.