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Why There's a 'Real' Change In Brazil

Macduff Everton | The Image Bank | Getty Images

Don't look now, but the bears on the Brazilian real are going into hiding.

It was only a little while ago that consensus forecasts had the dollar rising markedly against the real. But now expectations seems to be reversing course, with talk of the dollar possibly slipping below two reals.

What gives?

"We presume this view is being advanced by a group of economists at the helm of the central bank, including President Tombini," says Ilan Solot, a currency strategist at Brown Brothers Harriman. "It anticipates that, at the very least, the assumption on inflation is unlikely to hold."

Policymakers seem to be coming around to the idea that low inflation will be a challenge to maintain, Solot says, especially in the face of potentially rising energy costs and "the need to be nicer to financial markets if the government wants to realize its investment goals and not embarrass itself in the upcoming World Cup and Olympics." If inflation rises, there could be pressure to raise interest rates - which would likely send the real higher.

Then there is the fact that the central bank moved aggressively to defend the real when it slid past 2.10 to the dollar. Finance Minister Guido Mantegna said in a recent interview that currency and interest rate policies will be less aggressive than in the past because he anticipates solid growth.

Solot's view? That both the bulls and the bears are overshooting - and that the real still has appeal as a carry trade for the medium term.

"We doubt they will be willing to give so much ground as to let the 2.00 level go – if nothing else, as a matter of pride," he wrote in a note to clients. "We think USD/BRL is still stuck between 2.00-2.10 and promises a relatively low realized volatility going forward."

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