Last week I was in Rio de Janeiro. This country always fascinates me for the stark disparity on display between those who have a lot versus many of the citizens who don't have much. It is a city of contrasts.
Brazil started the century with tremendous promise and potential. It could do almost nothing wrong for the first six to seven years of the millennium. As a second source of agricultural and natural resource supplier to China, it grew in leaps and bounds. The wealth effect and aura of success brought it the 2016 Olympic Games as well as World Cup soccer. Right when Brazil was invincible, the bottom fell out, as the world slid into the 2008 recession.
China slowed down and Brazil got hit particularly hard. Matters were made worse when the incoming president was a populist and imposed regulations on businesses, which established significantly higher burdens of compliance as well as new taxes.
I kid you not, most businesses have between 25 to 35 taxes to pay each month. Just to monitor and stay in compliance, every company has to have a whole tax department just to stay open.
Fast forward to now, the Brazilian real has declined to as low as $3.25 before backing up to $3.00 (remember Brazil real is quoted European style so works opposite to logical direction).
But I do not believe we are over the worst for Brazil. The president was re-elected last year again and may not have learned all her lessons yet. The country does have a good finance minister now, but it is a tremendous battle uphill for him.
Deep-seated inflation has taken hold and is very stubborn in its staying power. The finance minister has a real challenge to be able to control inflation by raising interest rates but also allow businesses to flourish where he would have to reduce interest rates. He is caught between a rock and a hard place.
The good news is that he is fully aware of the difficult task ahead and is capable of facing the challenge. The bad part is that politics may not allow him free will to really cure the country of its ills.
I believe that the economy will decline into a small recession and the Brazilian real will decline by about 10 to 15 percent further in the next 18 months before things start improving.
As a trader, I would sell the real for now and continue to sell during bouts of strength. Granted the real is subject to the variances of the U.S. dollar but the inherent weakness will make it underperform the Latin American currencies.
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