The real Brazilian real

Posted by Tracy Alloway on Dec 02 08:43.

Just how overvalued is Brazil’s real — the currency at the centre of the country’s new capital controls?
By 31.3 per cent, according to Standard Chartered’s Mike Moran and Douglas Smith, who have just cut their short-term recommendation on the South American currency to `underweight’.
In graphic terms that overvaluation, which is based on the bank’s Real Effective Exchange Rate (REER) model, looks like this:
But what’s really interesting is StanChart’s reasoning for the change in their short-term recommendation:In our last FX Alert on BRL1, we maintained the BRL at Overweight despite the FX Model Valuation producing a net Neutral signal. Important considerations behind the override at the time were the strength of global risk appetite, especially for emerging market allocations, the relative strength of the Brazilian local economy and sustained weakness in the broader USD. These factors remain largely in place in 2010 and will continue to provide underlying support. However, fresh headwinds have arisen lately that indicate increased risk of a correction lower in BRL, or at least consolidation.
. . .
By our calculations, the BRL is over 30% ‘overvalued’ vs. the 5-year moving average (MA) and has now even overshot the average level of overvaluation since 2006. The Finance Ministry’s decision to impose a 2% IOF levy has also been key in turning sentiment. The long term impact on foreign direct investment into Brazil is not likely to be significant but the injection of fresh uncertainty on what future measures may be experimented with is now a key focus. In other words, Brazil has introduced a ‘policy risk premium’ that has been sufficient to delay further pressure on the BRL. We also see increased risks of a stronger USD in Q1 as the global economic recovery faces challenging headwinds in the form of fading positive base effects and broadening attempts by global central banks to unwind quantitative easing conditions. We are maintaining our medium-term FX rating at Neutral.

Related links:
Competitive devaluations threaten a trade war - FT
Brazil real `most overvalued’ currency, Goldman says - Bloomberg