Real not fully pricing improvement in Brazil’s Terms of Trade

“Unlike other EM currencies, the BRL has not benefitted as much so far from China reopening optimism since it emerged towards the end of last year.”

“The further improvement in Brazil’s terms of trade at the start of this year has not fully fed through to a stronger BRL. It reflects in part heightened concerns at the start of this year over domestic policymaking under new President Lula relating to both fiscal and monetary policy. We are assuming that these concerns will not escalate significantly in the near-term, and allow the BRL to be driven more by renewed China reopening optimism.”

“Long BRL positions continue to benefit from the favourable carry pick-up. The BCB is expected to keep rates elevated in the near-term at 13.75% despite government pressure to lower rates.”

“Volatility in the FX market remains at lower levels as well at the start of this year providing support for carry trades. The main risks to the trade include: i) a sharp increase in the domestic policy risk premium priced into the BRL, and ii) rising US yields eventually trigger a bout of higher volatility in FX & financial markets