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Emerging markets’ currencies have rallied about 2% from its year-to-date low in September 2nd, and the BRL beta adjusted seems to have lagged this recovery. This is a significant relative strength indicator as a short-term driver of BRL price action, in our view, and in the event that EMFX sees less pressures ahead BRL should catch up. Further, our short-term valuation models of the BRL explained by 2-year interest rate differentials, soft commodity prices, 10-year US treasuries and oil prices are showing the BRL about 6.5% cheap, with a fair value at 3.80 vs. the current level of 4.05 (25 cents cheap).
In fact, the oil attack over the weekend seems to have stop short a slight improvement in Latam currencies' tone, thanks to a "temporary deal" between China-US appearing, and ECB stimulus.
Stay OW BRL despite BCB dovishness. We maintain that the BRL is among the cheapest currencies in our region, and short BRL positions from speculative accounts have increased to the highest level this year, with BM&F data indicating long USDBRL positions at $37bn.
On one hand, lower growth and rates have taken a toll on BRL, but seem priced at this stage; GDP consensus estimations, as published by Bloomberg’s ECST seem to have stabilized, with 2019 GDP consensus estimations being little changed since mid-august.
Meanwhile, J.P. Morgan economists recently revised their 2019 GDP expectations to 0.8%, up from 0.7% before. On the other hand, political reform is still under way and the potentially large BRL inflows from the privatizations and oil auctions not far behind. We note that, according to the CNPE (National Council of Energy Policy), the excel oil auction will occur on November 6th, and the signing bonus of BRL106bn to be received on December 27th.
Risks of delays exist, particularly since this is a very tight schedule, but market participants may anyway position ahead of these dates, and the foreign O&G companies involved are likely to convert their FX into BRL ahead of this time frame. We also recommend a 1x2 USDp/BRLc structure (4m, K = 4/4.20) costing 118bp. Courtesy: JPM
