Great post by Fabio Kanczuk regarding the higher correlation of the BRL-AUD in comparison to the BRL-USD. He makes his case on why the recent depreciation of the BRL is temporary (he still thinks it will converge back to 1.67). Although we do not agree with him (we think the intrinsic value of BRL is close to 2.0), his analysis is valid and has its merit. It goes something like this (below the graph):
“Both currencies (BRL, AUD) react similarly to two types of shocks: changes in commodity prices (Australia also exports commodities) and (ii) changes in global risk appetite (which moves the U.S. dollar in relation to all others). For these reasons, the AUDBRL is much more constant than the USDBRL. During September, the USDBRL went from 1.59 to 1.71 (7.5% spread), while the AUDBRL moved from 1.70 to 1.78 (4.70% spread). If the above hypothesis is correct, this 4.7% spread was not caused by commodities or risk aversion (the crisis of Europe). The most natural explanation is that the depreciation of the BRL was due to interest rates changes, which occurred on August 31.”
He believes that 1% depreciation makes sense, but the remaining 3.7% was an “overshoot”.
Full article here.