Brazil's Real Held Hostage by Reforms Seen as Non-Negotiable

(Bloomberg) -- The Brazilian real’s stuck in a rut, and only a drastic change in the outlook for a pension reform designed to shore up public finances may be able to shake it loose, in either direction.

The currency has mostly traded within its 50- and 200-day moving averages for the past month as optimism over yet-to-be-enacted economic reforms has not been enough to spark a rally amid slumping commodity prices. A recovery in raw-materials on Monday pushed the real below its 50-day moving average, but analysts say in the longer run there is no driver more important than the government’s measures to improve the fiscal accounts.

Such reforms, including increasing the retirement age and the minimum period for social security contributions, are seen as essential to turning around the economy. Top forecasters for Latin America’s currencies say even though congressional approval of the pension could give it a boost, potential triggers for a wider move in the short term are skewed to the downside. Any sign of a delay in the reforms, a continued decline in commodity prices or a rally in the U.S. dollar could send it reeling.

Brazil's Real Held Hostage by Reforms Seen as Non-Negotiable

"We expect the dollar to recover on better U.S. data and some pickup in U.S. nominal and real yields, which will probably weigh on the real," said Georgette Boele, a strategist at ABN Amro Bank NV in Amsterdam. She forecast the currency will end the current quarter close at 3.2 per dollar, and decline to 3.3 by the end of the year. It was at 3.1231 Friday.

Much of the optimism on the improvement of the economy has already been priced in, adding some discomfort with any strengthening of the real. The currency’s one-month implied volatility has declined 20 percent this year.

Brazil's Real Held Hostage by Reforms Seen as Non-Negotiable

Any news the government pension reform will pass sooner than expected could boost the real, said the most accurate forecaster for Latin American currencies in the first quarter, according to Bloomberg rankings. The measure is essential to trim the budget deficit and cap public debt, which is on an upward trend, and resulted in the loss of the country’s investment grade two years ago.

"In the longer run, there is no driver more important than the pension reform approval," said Gustavo Rangel, an economist for Latin America at ING Financial Markets LLC in New York. He sees the real overshooting to 2.9 per dollar if and when the reform is endorsed, which is his base-case scenario, and ending the year at 3.1 per dollar.

Supporting the call for a stronger real is Brazil’s carry-trade return, which remains one of the juiciest in the world: buying the real with borrowed dollars has returned 24 percent in the past year, second only to Russia’s ruble among 42 currencies tracked by Bloomberg.

"Many investors are waiting for the reform approval to put money in Brazil," Rangel said.