The Short on Brazil

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Brazil has the fastest growing economy in Latin America. Their economy grew at over 7% in 2010, and is forecast to grow over 5% in 2011. They have a lot of what the world wants - oil, fertilizer, grains, etc.

But recent events have given the markets cause for concern...

On Jan 19 Brazil raised interest rates from 10.75% to 11.25%, and the central bank has warned that this could be just the beginning of a series of interest rate hikes. As well large increases in bank reserve requirements have been implemented to try and slow lending.

The strong Brazilian real is already hurting exports and higher interest rates will have the effect of bringing in even more foreign money searching for yield, which will put further upward pressure on the currency. The real has risen by over 30% against the USD over the past 2 years and is considered by some to be the most overvalued currency in the world.

So we have an economy that is booming - but rising inflation, rising interest rates, and a strengthening real are presenting a risk.

Brazil's stock market was one of the few laggards in 2010. The stock market (using EWZ as a proxy) was essentially flat in 2010. In fact in 2010 it put in was looks like a double top around 80.

And now the dailies are starting to break down. On Feb 9 the Brazillian ETF (EWZ) broke down through 72, a key technical support area representing both a previous support/resistance line, as well as the 200 day moving average.

I used today's bounce back to 72 to short EWZ @ 71.96. My medium term target on this trade is 62. A move above 74 would be required for me to reconsider.