• Alan Brazil

Fade Political Change: Buy Mexican Peso, Sell Brazilian Real


Ok, I get it. Potentially plenty of bad things could be coming for Mexico from policy changes by the new US president: a wall, tariff on car imported from Mexico, scrapping of the trade treaty. In contrast, potentially plenty of good things could be coming for Brazil from policy change from their new government: reform of pensions, austerity, lower interest rates, support for capital inflows to build infrastructure. Clearly, this differentiated view of the potential impact of political change is a major factor driving the rally in the Real vs the Peso since the summer in the aftermath of the crash in commodity prices. I am arguing to fade the rally in the Real vs the Peso because the potential difference in the impact of political changes will give way to the reality of the large and growing differences in the two economies.

First, as I argued in my SOM Brazil, political reform in Brazil is unlikely to give much of a lift to the Brazilian economy, and is more likely to slow it further. More importantly, the probability of implementing fundamental reform is low, in my view, given the policies reality of the likely pushback from those who will be most affected by reform. Second, the Mexican economy is much stronger and in much better shape than the Brazilian economy, again as I showed in my SOM piece. If anything the weakness in the Peso gives them an added tailwind from trade. In addition, the Mexican government has already pushed through many of the reforms that Brazil is thinking about. Finally, just as in the case of Brazil, potential US policy moves in the aftermath of the US elections are just that potential. Can the new government really implement economic policy that will substantially affect the real economy of Mexico that will also affect the economy of Texas and Arizona? Further, the net effect on the Mexico economy could be minor given that their economy will also be helped by other US policy moves that stimulate the US economy.

So, I am arguing to fade political change and buy the Peso and sell the Real. This trade has significant asymmetry. First, the downside is limited because the potential impact of government policy changes has been priced in to a large degree. Second, there is upside in both currencies if either the US or Brazil do not follow through with actual policy moves. Third, there is upside in the trade even with policy actually being implemented because the Mexican economy will continue to outperform that of Brazil.


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