If this is the turn in the dollar cycle, it could mark the sweet spot for flows into emerging market asset markets – particularly EM local currency bond markets. Both Brazil and Mexico have relatively large weights in these benchmarks and their currencies could perform well as this asset class comes back into fashion
This month we are having to acknowledge the better prospects for the Brazilian real, where some welcome reforms and what should be the start of a significant easing cycle are improving the outlook for Brazilian asset markets. On the former, the new fiscal framework and what seems to be consumption tax reforms are supporting the narrowing in Brazil’s sovereign risk premium.
Low inflation, now below the central bank’s 2023 inflation target, is also raising expectations that BACEN can cut the Selic rate aggressively. A first cut in the 13.75% rate is expected in August, with around 400bp of easing expected over the next year.
If we are right with the dollar turning lower later this year, it looks like BRL can outperform the steep forwards curve.
