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How Correlated Are Brazilian Equities to Its Currency?

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Apr. 8 2016, Published 8:54 a.m. ET

What problems are impacting Brazil?

There are a series of problems for Brazil (EWZ) that haven’t be resolved such as spiraling unemployment, high inflation, political turmoil, stagnant economic growth, high fiscal deficit, deep recession, and downgrades from rating agencies. The economy is continuing its downturn due to a slide in commodity prices and political and economic instability in the country.

Brazil’s major commodity producers and exporters such as Vale (VALE), Petrobras (PBR), Gerdau (GGB), and Companhia Siderúrgica Nacional (SID) were impacted negatively due to China—the country’s major export destination. China showed a slowdown in its demand for commodities.

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Brazilian equities and its currency

The Brazilian economy depends on commodity movement. The equity market is an important leading indicator of the country’s economy. However, the fall in the Brazilian real was due to investors’ concern about the future outlook of the Brazilian economy. Instability in political situations and several downgraded ratings from rating agencies shattered investors’ confidence in the economy.

Again, a weaker currency increased inflation without any economic growth. The country’s inflation is still at 10.4% despite the Brazilian Central Bank’s efforts. This resulted in a simultaneous fall of the equity market and the country’s outlook. In the past three months, the Brazilian equity index had a correlation of 64% with its currency. This is higher on a historical basis. The above chart shows the correlation of Brazilian equities with its currency.

In the next part of this series, we’ll discuss what’s driving Brazil’s currency rally.

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