A rebound in economic activity and near-term stabilisation in the fiscal accounts has alleviated pressure on the Brazilian real

Although the economic outlook in Brazil remains shrouded in uncertainty as the Covid pandemic continues to rage, pressures on the currency have appeared to ease somewhat.

Charts Source: Bloomberg, Macrobond and Variant Perception

CFTC data show a sharp unwind in BRL short futures contracts in recent weeks, which has allowed overall positioning to return towards neutral. At the same time, the previous drawdown in hard currency reserves and intervention via BCB USD Swaps appears to have stabilised through the end of 2020.

Charts Source: Bloomberg, Macrobond and Variant Perception

Meanwhile, our Brazil leading indicator points to a sharp rebound in economic activity following a hefty contraction.

Charts Source: Bloomberg, Macrobond and Variant Perception

Even though the manufacturing PMI appears to be rolling over, at 61.5 in December, the survey still suggests that the industrial sector will enjoy a sprightly recovery in the coming months.

Charts Source: Bloomberg, Macrobond and Variant Perception

Brazil’s yawning budget deficit remains a cause for concern, but even that has shown signs of improvement towards the end of last year.

The expiration of pandemic-related emergency cash transfers to households at the end of December has provided immediate respite to public finances. And despite pressure to ramp up spending further, government appetite for additional support appears to be waning.

Charts Source: Bloomberg, Macrobond and Variant Perception

President Jair Bolsonaro recently quipped that “Brazil is broke” when meeting a supporter and is backing a candidate for the position of Lower House Speaker who has pledged to uphold the fiscal spending cap (limiting government spending to the previous year’s inflation rate) and would seek a constitutional amendment to do so.

While there is certainly a temptation to keep the spending taps open, market pressure provides much needed discipline. Market sentiment is fragile and with developed market governments shifting focus from pandemic spending to post-crisis fiscal consolidation, Brazil has less scope to expand the deficit further if the government wants to maintain low funding costs.