A Silver Lining in BrazilThe USDBRL recently broke above a descending channel, signaling further BRL weakness; an unusual occurrence given the ongoing shift to easing cycles by major global central banks.
Figure 1: Major Central Banks Begun Rate Cuts; USDBRL Rises Instead
On September 18th, the Federal Reserve (Fed) cut rates by 50 basis points, marking its first reduction since the pandemic. Several other central banks, such as Bank of Canada (BOC), European Central Bank (ECB), have continued their ongoing rate cut cycle in the past few months. While uncertainties remain about the pace and extent of these cuts, there is a clear consensus among major central banks to adopt a dovish stance.
Historically, monetary decisions by major central banks, especially the U.S. Federal Reserve (Fed), have directly influenced the USDBRL exchange rate. Higher U.S. rates attract capital inflows, strengthening the USD and weakening the BRL. Consequently, one would expect USDBRL to continue trending lower in line with anticipated rate cuts. Instead, USDBRL recently surged to levels reminiscent of the pandemic era, defying conventional expectations.
Figure 2: Brazil’s Central Bank Acts Swiftly on Inflation
The Brazilian Monetary Committee (COPOM) was one of the earliest to react to rising inflation, initiating aggressive rate hikes as early as 2021. This preemptive stance set COPOM apart from other major central banks, which only began tightening in 2022. The much more aggressive hikes helped stabilize the BRL, leading to a sustained downtrend in USDBRL.
The COPOM has also been quick to address the recent reversal in inflation trends. A 25-basis-point rate hike in September and November signals the start of a monetary tightening cycle aimed at countering inflationary pressures, especially in food and energy prices.
Figure 3: COPOM Leads Global Rate Hike and Rate Cut Cycles
Although COPOM began cutting rates in the second half of 2023, global narratives remained focused on the U.S.'s potential for a soft landing. Amid the lack of confidence in post-pandemic recovery and lack of direction in major central banks’ stance on rate hikes, capital stayed in developed markets. However, the latest cuts from major central banks suggest a shift toward more accommodative policies, potentially sparking renewed interest in riskier emerging market assets. Brazil stands to benefit from this shift, particularly following COPOM’s decision to raise rates. Yet, the recent USDBRL breakout suggests a market sentiment that is incongruent with these developments.
Figure 4: Divergence Between Brazil’s Ibovespa and S&P 500 Continues
This odd occurrence extends to the equity market as well. Back in March 2024, we noted the divergence between the S&P500 and Ibovespa. While the divergence narrowed slightly after, the S&P500 benefited from the subsequent AI-driven gains, and Brazil’s Ibovespa futures lagged. This reflects a broader uncertainty surrounding Brazil’s financial outlook.
Figure 5: Brazil’s Overall Flow Remains Positive
The trade balance measures the difference between exports and imports of goods and services whereas the capital flows measure the ownership of Brazilian assets by foreigners against foreign assets owned by Brazilians. This can include foreign direct investment, portfolio investment and other investments.
Despite episodes of capital outflow in 2024, Brazil’s trade surplus has been relatively stable, which has effectively provided a buffer. Throughout the first half of 2024, the net positive combined inflow signals an overall greater demand for the BRL and ought to provide additional support for the currency.
Moreover, China’s recent stimulus measures are likely to have a positive impact on Brazil. As a major commodity exporter, Brazil’s trade figures are closely tied to China’s economic performance. The announcement of China’s 2025 investment budget for construction projects is expected to further boost Brazil’s trade numbers.
Though there is different dynamics in international trade and investment, market sentiment still weighs heavily on bearish expectations on Brazil’s financial market over her strong trade capabilities.
Figure 6: Brazil’s GDP Shows Robust Growth
Brazil’s central bank recently revised its 2024 growth forecast upwards, citing stronger-than-expected data. Brazil’s GDP grew by 1.4%, while real GDP expanded by 2.68%, rebounding after two quarters of stagnation. With annual GDP growth projected to hit 3% by the fourth quarter, Brazil’s economy is proving to be more resilient than market sentiment suggests.
Figure 7: Brazil’s Labor Market Remains Robust
While the market panicked over U.S. unemployment rate spike in July, Brazil’s unemployment rate has been consistently declining, a clear indication in a significant improvement in labor participation rate. Furthermore, wages, benchmarked using real earnings, have shown significant recovery post-pandemic, reaching new highs. This labor market strength further supports the fundamentals of the Brazilian economy.
Figure 8: Brazil’s Fiscal Concerns Weigh on Sentiment
Brazil’s rising government debt and debt-to-GDP ratio have raised concerns among investors, highlighting a significant fiscal challenge. While the debt-to-GDP ratio had improved in recent years, 2023 marked a reversal suggesting a possible upward trend that alarmed markets. This is compounded by the government’s recent decision to relax budget targets for 2025 and 2026, extending the timeline to achieve fiscal surplus. Such moves signal a longer period needed to stabilize Brazil’s growing public debt, prompting fears of higher future inflation and questions about the government’s commitment to fiscal discipline. Investors worry that these factors could lead to elevated inflation expectations and erode the perceived value of Brazilian assets, demanding higher risk premiums to compensate for fiscal uncertainty.
Every Cloud has a Silver Lining
Despite these fiscal challenges, Brazil’s economy continues to demonstrate resilience. Trade surpluses remain robust, GDP growth is positive, and the labor market is strong. COPOM’s recent rate hike signals its determination to combat inflationary pressures. Brazil’s Treasury Secretary, Rogerio Ceron, has pledged to outperform fiscal targets, while Moody’s recent credit rating upgrade in October places Brazil just one notch below investment grade. This contrast between solid economic fundamentals and fiscal instability has created a situation where the market appears overly focused on Brazil’s fiscal risks, potentially mispricing the country’s overall economic health. Consequently, this divergence highlights a lopsided risk premium that investors may exploit, particularly by engaging in relative value trades on the yield curve.
Gaining Access to the Yield Curve
Brazil’s main interest rate contract, the DI Futures which is traded on the B3 exchange, reflects the expectations of the market for the average DI Rate over a specified period – starting from the trade day (inclusive) to the contract’s maturity date (exclusive). The DI Rate is the average rate for one-day Interbank Deposit Certificates (CDI) traded between different banks but, nowadays, considering their methodology and the current market dynamic, this rate has the same value of Selic Over Rate (Brazilian interest rate benchmark that will follow the Selic Target Rate). The Selic Target Rate is the interest rate set by the COPOM and used by the Brazil Central Bank in the implementation of the monetary policy. Both local and non-local investors trade the DI Futures to express their views and expectations of the Brazilian yield curve, making DI Futures one of the most liquid interest rate instruments traded globally. Furthermore, B3’s COPOM Option Public Dashboard provides a convenient visualization of such market sentiment – Selic Target Rate probabilities decided at each COPOM meeting. These probabilities are calculated with B3’s COPOM Option contracts.
All DI Futures contracts are cash settled and payout 100,000 BRL at the end. The total profit and loss will include all the daily settlement to be carried out until the expiry date. Since the DI Futures contract is quoted in rates, to express the view of a rate cut, an investor can simply short the DI Futures in the respective maturities being studied. Furthermore, by analyzing DI Futures rates across shorter maturities, investors can gauge market sentiment regarding future COPOM actions while rates across longer maturities reflect sentiments on the broader outlook on economic conditions. An example to interpret the DI Futures rates and calculate the daily settlement is provided by B3 under the topic of directional positions.
Figure 9: Setting up the Trade
Evidently in Figure 2, the COPOM has always reacted promptly to address any reversals in inflation trend. As it is incredibly difficult to predict future inflation trends and other economic conditions, it is therefore difficult to predict COPOM’s reaction in the future. As such a directional trade on DI Futures can prove to be relatively risky.
As of 10th Nov 2024, the rates quoted by the DI1F35, expressing a 10-year view, and the DI1F27, expressing a 2-year view, are at 12.49% and 13.09% respectively, resulting in an inverted yield curve.
Considering Brazil’s strong economic fundamentals, the current inverted yield curve appears overly pessimistic. A trade, constructed with DI1F27 and DI1F35, that anticipates a normalization to a positive yield curve could be profitable. To set up the trade, we would have to calculate the sizing ratio from a Basis Point Value (BPV) neutral perspective. The computation is shown in the table below.
We would consider taking a long position on the forward rate strategy by selling 100 DI1F27 futures and buying 55 DI1F35 futures. Each basis point move in the DI1F27 leg is 100 * R$ 14,46 = R$ 1.445 and each basis point move in the DI1F35 leg is 55 * R$ 27,35 = R$ 1.504. Evidently, each basis point move in the DI rate would have roughly the same profit and loss impact on either contract. This is achieved by the BPV neutral calculation.
From Figure 9, we would place the stop-loss at -0,65, a historical support line, for a hypothetical maximum loss of 5 basis points, 5 * R$ 1.504 = R$ 7.520. Likewise, we would place the take-profit at 0,93, a historical resistance line, for a hypothetical gain of 153 basis points, 153 * R$ 1.446 = R$ 221.238.
In conclusion, this relative value trade would be more favorable. As expressed in this trade, the normalization could happen as a result from either a rise in the DI1F35, a fall in the DI1F27, or a concurrent rise and fall in the DI1F35 and DI1F27 respectively. This proves that a relative value trade is likely to be less risky as compared to a directional bet on the Selic Target Rate using one DI Futures contract.
Ibovespa
Divergence Unveiled: Ibovespa & S&P500“Emerging markets conclude 2023 on better note than developed markets” – S&P Global Market Intelligence.
How much of this has been reflected in the respective market indices?
Figure 1: Ibovespa and E-mini S&P500 Index Futures
Figure 1 presents a retrospective view of the Ibovespa Index Futures (IND1!) and E-mini S&P500 Index Futures (ES1!) since the onset of the pandemic. While the indices initially traded in tandem, a noticeable deviation emerged since the middle of 2021. The IND Futures to ES Futures ratio testing long-term resistance at 25 raises questions about a potential rebound or breakout to the downside. Let's delve into the methodologies of these two index futures to gain insights into their recent divergence.
Index Methodology and Weightings
Figure 2: Top 10 Constituents of Both Indices
Examining the top 10 constituents of both indices in Figure 2, we observe fundamental differences. Despite their similarities as float-weighted benchmarks for large-cap stocks in their respective countries, the Ibovespa Index comprises 86 stocks compared to the SP500's 500. This fundamental distinction results in a significantly larger total weight for the top 10 constituents of the Ibovespa Index, suggesting that IND future prices are more susceptible to the performance of its leading components.
Ibovespa Driven by Global Commodity Prices
Figure 3: Ibovespa vs Brent Crude Oil, Nickel, and Iron Ore
Dominated by the Energy, Financials and Basic Materials sector, the combined weight of VALE SA and PETROBRAS holds significant influence. While VALE SA is the largest producer of iron ore and nickel in the world, PETROBRAS is heavily involved in the petroleum industry. Their earnings are likely to increase following an increase in the traded prices of iron ore, nickel, and crude oil, respectively.
Positive correlations with Nickel, Iron Ore, and Crude Oil Futures prices indicate periods marked in grey boxes since the pandemic, where fluctuations in commodity futures potentially explain observed patterns in IND prices.
Figure 4: Global Commodity Index
Hence, given IND1!'s demonstrated sensitivity to commodities, understanding the general trajectory of commodities becomes paramount. The S&P Goldman Sachs Commodity Index (GSCI) provides an overview for commodities. In Figure 4, the GSCI acts as a good proxy for the commodities cycle and direction, here we observe a 30% correction from the peak, erasing some of the gains derived from the post-pandemic recovery and the Russia-Ukraine war. However, since the beginning of 2024 we see signs of a potential trend higher with the index starting to creep higher.
Figure 5: Bullish Trends Observed on Multiple Commodities
Is this just part of the usual price volatility for commodities or is the move higher significant? A detailed scrutiny of recent price movements in Figure 5 reveals a bullish outlook for all three previously examined commodities, relevant especially to the Ibovespa Index. The breakout from an ascending triangle in Brent Crude Oil Futures, the price rebound from historical support in Nickel Futures, and the testing of the upside trendline in Iron Ore Futures collectively indicate a prevailing bullish bias, perhaps suggesting more to the broader move higher for commodities.
Are Lower Rates Better?
Figure 6: Changes in Rates and USDBRL on Ibovespa
The Financial Sector, with significant weight in the index, is examined. While higher interest rates expand profit margins of financial institutions, extended periods of tight monetary policy can expose vulnerabilities and increase loan losses.
Since August 2023, Brazil’s Central Bank Monetary Policy Committee, Copom, has had five consecutive rate cutes up to a cumulative total of 250 basis points while the market continues to alter bets on the Fed’s first rate cut. Intriguingly, while interest rate parity would suggest a strengthening USDBRL, the observed weakening suggests a unique deviation.
Furthermore, as the Fed gains more confidence, evidenced by each data print, the likelihood of impending rate cuts becomes more apparent. Conversely, the outlook for further cuts by Copom is less clear due to persistently high inflation. Interpreting these factors collectively points towards a weaker USDBRL and a correspondingly stronger IND1!; as suggested by the historical inverse relationship between Ibovespa and USDBRL observed in Figure 6.
Additional Support for Ibovespa
Figure 7: Brazil’s Growing Net Exports
The rolling average of the net exports, although exhibiting some degrees of seasonality, seems to be a leading indicator of the IND prices. The reversal and positive trend in the rolling average of net exports since 2015 aligns with the climbing IND prices, indicating substantial support from Brazil's trade balance.
EM Still an Attractive Option
Figure 8: Comparing Both Index Futures’ RSI
Figure 8 brings to light yet another noteworthy point, using the ES1! as a proxy for the Developed Markets (DM) and the IND1! as a proxy for Emerging Markets (EM), we see the DM significantly overbought relatively to the EM. Hence, we argue that there is further room for the EM Index to grow.
Putting into Practice
Figure 9: Setting up the Trade
Looking at a shorter timeline, Figure 9 unfolds a compelling narrative marked by a recent decisive breakout from an inverse head and shoulders pattern. This breakout, coupled with the notable reversal in commodity prices, Brazil’s improving balance of trade, a weaker USDBRL, and the RSI not yet overbought; we lean bullish on the IND1!.
To express this view, we can long the Ibovespa Index April 2024 Futures (INDJ4) at the current price level of 129,070.
• We can set the take profit by adding the difference between the neckline and the bottom of the head (24,695), to the neckline (121,980). This puts our take profit at 146,675 and a hypothetical gain of:
146,675 – 129,070 = 17,605 points.
• Likewise, we can set the stop loss at the neckline (121,980), which brings us a hypothetical maximum loss of:
129,070 – 121,980 = 7,090 points.
• Each point is equivalent to 1 BRL.
Overall
In summary, understanding the intricate dynamics between global commodity prices, monetary policies, and trade balances provides valuable insights for anticipating the trajectory of the Ibovespa Index Futures in the evolving financial landscape.
IBOVESPA's 2 Year Rising WedgeSince the Coronavirus Pandemic, IBOVESPA has been in a rising wedge pattern. There are key spots in the pattern. This ups the chances of IBOVESPA dumping, since the pattern has been there for so long, and it is still in action. We don’t know what will happen. The most probable thing is that it will dump. All we need to do is wait. BMFBOVESPA:IBOV
IBOVNow sucking up to my country. We have an index doing better than SPY! After we have broken through this lower channel, we come back to the surface. We are practically already activating a bullish pivot, we now need confirmation. Entering the fundamentalist part. Countries from abroad are coming to invest in our Brazil index as our index is doing better than others.
DISCLAIMER: Please note that my studies portray my personal opinion only and should be considered for educational purposes only. They should not be considered as a recommendation to buy or sell an asset!
I am not responsible for any damages to your capital. Your capital is at risk in the equity market.
Long Ibovespa indexAfter this week's candle, the market has refused to go lower and the bulls answered by buying with high volume and high momentum, closing its candle above the previous higher. The 10 EMA is likely to reverse its doen pattern to up indicating a very strong signal to buyers with a risk reward ratio of 1:2.
IBOV/WIN Sell IdeaLONG AND RISKY TRADE
Perhaps a late entry, but it might be worth it since fundamentalist analysis corroborates with this view.
Dragonfly pattern on the Daily chart.
SL is right above the last high
TP1 is right at Fibo's 38.2%
TP2 is right at Fibo's 50%
TP3 is right at Fibo's 61.8%
I would highly suggest moving SL to BE as soon/if it reaches 23.6% of Fibo.
S&P500 - BIG SHORT - 🤐Hey guys, ok? A great weekend everyone!.
Be very careful guys at the S & P500. 9 is a very high trend change indicator.
Fundamental Analysis: The post-corona pandemic is just beginning.
To my friends from Brazil. Ibovespa is currently well connected with S&P 500
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