What happened

Brazilian stocks went into free fall yesterday, with shares of oil major Petroleo Brasileiro (NYSE:PBR) closing down 3.7%, and preferred shares of Petroleo Brasileiro (NYSE:PBR-A) losing 6.1%.

Confirming that this was not an "oil story" but a "Brazil story," shares of Brazilian airline Azul SA (NYSE:AZUL) and Brazilian steel company Companhia Siderurgica Nacional (NYSE:SID) likewise declined steeply -- closing down 7.2% and 4.8%, respectively. Overall, the Brazilian Ibovespa benchmark stock index closed down 3.7%, after falling as much as 6% in trading earlier in the day.

Map of Brazil with a pin in it

Stick a pin in it? Is Brazil done? Image source: Getty Images.

So what

That's the bad news. Now here's the good: All three of these stocks, and the Ibovespa as a whole, are getting back up off the mat and back in positive territory this morning. But why did they sell off yesterday in the first place? Simply put, the country's currency is in crisis. Yes, again.

As The Financial Times (FT) reported yesterday, the Brazilian real "has sunk to levels not seen since the country's impeachment crisis two years ago." Relative to the U.S. dollar, the real has seen 15% of its value evaporate over the past three months, including a 4% drop over just the past two days.

FT blamed the declines on investors losing confidence in the federal government after a truckers strike motivated the government to impose price controls. Additionally, moves by the central bank to salvage the real have fallen flat.

Now what

Unless something happens soon to change this dynamic, FT warns that "policymakers may be forced to raise interest rates above their current record low levels to contain the fall in the currency's value." And even that type of action isn't guaranteed to succeed, in which case Brazil could find itself caught in a classic case of stagflation.

As if all this weren't already bad enough, presidential, congressional, and gubernatorial elections are all on the horizon in October. The candidates most likely to win hail from the country's extreme right and left wings, too -- neither of which is expected to be interested in reforming Brazil's system of social security, a step that is considered crucial to stabilizing the country.

Now here's the upshot for investors: After yesterday's sell-off, Azul stock is back up 3.9% in Friday trading, Companhia Siderurgica Nacional has regained 0.5%, and Petrobras is back up 0.2% (for the common stock) and 2.5% (for the preferred) as of 11:50 a.m. EDT. That's good news for today -- but the challenges that sent all three stocks reeling yesterday are far from solved. Expect more volatility until they have been solved.

Rich Smith has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.