Morning Note /

Latam Daily: Brazil’s fragile political space coming to a head

  • Brazilian sell-off continues

  • Colombian Congress approves 2022 spending package

  • IMF to release its Regional Economic Outlook for Latin America and the Caribbean report

Lloyd Miller
Lloyd Miller

Head of Developed Markets and Latin America Research

Daron Hendricks
Danny Greeff
Kieran Siney
ETM Analytics
21 October 2021
Published byETM Analytics

Talking Points: Brazilian Senate driving political risk

Brazil: The Senate is accusing President Bolsonaro of crimes against humanity due to his government’s handling of the COVID-19 pandemic. A Senate commission presented a final report on Wednesday after six months of hearings and discussions, which included testimony from former Health Ministers, companies that pushed for unproven treatments and COVID-19 patients. Brazil has recorded more than 600,000 deaths from the COVID-19 pandemic, second only to the US. President Bolsonaro has been blamed for the government’s handling of the pandemic, shunning of face masks and vaccines and encouraging his supporters to ignore lockdown measures enforced by states and cities to curb the spread of the virus.

Mexico: Mexico’s annual inflation is forecasted to reach 6.50% by the end of the year, according to the median estimate in a survey of economists by Citibanamex published yesterday. Compared with 6.31% forecasted just two weeks ago, the updated reading would put Mexico’s year-end inflation well above the central bank’s target rate and confirms expectations of persistent price pressures within the domestic economy. According to the minutes of its September meeting, the majority of the bank’s board members see upside risks to price gains. Moreover, 2022’s year-end inflation figure was revised higher to 3.83% from 3.80% previously. Meanwhile, the nation’s economic growth estimate for this year was cut by 0.1 percentage points to 6.10%. Next year’s GDP reading was held constant at 3.00%. The analysts foresee the central bank’s next rate move being in November, with a predicted 25bps interest rate hike increase.

Colombia: Colombia's Congress approved the 350.4trln COP spending package proposed by the government for its 2022 budget, marking the second consecutive year it has approved a record sum. The budget is 5.3% bigger than the previous record approved for 2021, with funds earmarked to ease economic pressures caused by the pandemic. The budget is predicated on an economic growth target of 4.3% for 2022, compared with the government's forecast rate of 6% for this year, and uses a fiscal deficit target of 7% of GDP for 2022.

Chile: Economists and strategists are in unison that inflation will remain a feature for some time to come, both globally and locally. One of the major drivers of inflation at the moment is the high cost of energy, specifically oil and natgas. The higher fuel price has contributed between 13% and 15% of the total rise in local inflation over the past two months and the pressures are expected to last at least until the end of 2021. The political landscape, meanwhile, is hotting up as we head into next month’s Presidential elections. Investors have been rattled by earlier thoughts that the left leaning presidential candidate, Gabriel Boric was looking to abandon free trade agreements. This has been refuted by his representatives Diego Pardow and Juan Ignacio Latorre in an opinion letter sent to El Mercurio.

Peru: Unsurprisingly, President Castillo will challenge the recently approved law in Congress that limits his power to dissolve it. The government will be asking the country's top court to declare the law as being unconstitutional, needing five votes to win its case. No details are out yet regarding when the case will be heard and when an outcome can be expected. Even if the law is overturned, Congress has used it to send a message to Castillo, telling him that not all of them are on his side and that power within the country will still rest with them

Forex: Brazilian Real the underperformer again

Brazil: The sell-off in the BRL persisted on Wednesday, with the local unit extending its losses to a third straight session. Specifically, the BRL ended the session 0.24% weaker against the USD at 5.5982, making it the second-worst performing emerging currency on the day. This comes after the BRL reversed its earlier gains, which was driven by central bank interventions and fiscal reassurances. Note that the BRL was amongst the best performing EM currencies in the first half of the session, gaining as much as 1.15%. The fact that the BRL reversed its earlier gains and ended the session weaker despite intervention from the central bank in the FX market bolsters the notion that the bias in the local currency remains decisively bearish.

From a technical perspective, while the bias in the USD-BRL remains to the topside, the pair has hit a level of stern resistance at 5.6000. The USD-BRL has tested a break above this psychologically important level on Tuesday and Wednesday but failed to sustain the move. Looking ahead, if the pair can sustain a break above the 5.6000, it will open the door for another topside run in the pair. .

Mexico: The USD-MXN bears challenged the technical support area between 20.1000 and 20.2240 yesterday, breaking below the first support (the 50DMA at 20.2145) and the 200DMA to print an intra low of 20.1591 before settling at 20.2022 – a three-week low. Commodity currencies are benefiting from strong raw material prices, as the improved risk appetite has seen investors gradually trim their demand for the safe-haven USD. Technically, the USD is showing signs of vulnerability and the likelihood of a deeper sell-off. The USD-MXN, however, is bid heading into the US Open, advancing back towards 20.3000. So far, the USD-MXN stochastics downside trend is bottoming out, suggesting that the 20.000-handle may prove to be the floor for the pair in the near term.

Colombia: The COP consolidated for a third straight session on Wednesday, closing flat after some mild volatility through the session. The market appears reluctant to take the COP beyond the 3750.00/$ mark, with much of the recent oil price rally and prospective BanRep rate hikes already priced in at current levels. Further consolidation thus appears likely in the near term, which would point to a potential turnaround with momentum gradually shifting in favour of the bears.

Chile: The CLP stalled above the 810 mark overnight despite the better performance of the copper markets and the USD being under pressure. As mentioned before, political and fiscal risks are now well embedded in the currency and we would be paying the offer on any dips towards the 800 mark.

Peru: The PEN held relatively flat through the session once again yesterday, holding near 3.9500 after the recent rally took it to highs around 3.9000. Traders digested the news from Congress which has brought a halt to the recent rally. With copper prices still strong and the USD recovering marginally today, it is looking likely that consolidation will be the order of the day again. The abovementioned levels remain the key resistance and support markers to watch.

Fixed Income: Investors continue to exit Brazilian bonds

Brazil: Like a rocket to space, Brazilian bond yields continued to surge on Wednesday, driven higher by a combination of mounting political and fiscal fears and increasing bets for the central bank to scale up the pace at which it is hiking interest rates. Yields across the curve skyrocketed yesterday, with the 2yr yield legging 34bps higher to 10.99%, while the benchmark 10yr yield jumped 33bps to 11.87%. Note that since the start of this week, the 2yr yield has increased by 92bps, while the 10yr yield has climbed 78bps.

This is one of the most significant sell-offs in Brazilian bonds this year and underscores just how severe fiscal and inflation risks are at the moment. That said, President Bolsonaro said on Wednesday that the new welfare program that he recently approved would not breach the spending limit. However the President failed to give details on how that would be achieved.

Just hours after President Bolsonaro’s statement, Economy Minister Paulo Guedes said the government could seek a waiver to the spending cap rule to fund its new social program. Guedes said the administration could ask Congress for a BRL 30bn waiver to the spending cap in order to pay for a larger social program. The Minister added that the exception would be limited to 2022 and justified by the fact that poor Brazilians are being disproportionately affected by food and fuel inflation. While this would not result in a direct breach of the spending cap rule, it will still trigger a wave of concern amongst investors. As mentioned in recent commentary, while risks remain elevated, at current levels, Brazilian bonds offer investors an attractive yield.

The combination of worsening external conditions and growing concerns over Brazil’s fiscal outlook has seen Brazil’s credit risk premium surge to its highest level since April. Specifically, Brazil’s 5-year USD credit default swap, which is essentially the cost of insuring against sovereign default, has risen by 11bps this week to sit at 213bps. While fiscal risks in Brazil have intensified in recent days with the government preparing for a bigger-than-expected social program, the risk of Brazil defaulting on its debt remains low. Note that while Brazil’s debt pile is significant relative to many of its emerging market peers, Brazil has little exposure to foreign currency debt.

Mexico: Mexican bonds consolidated yesterday. A key driver for bond markets is the withdrawl of pandemic stimulus measures in the upcoming months amid pockets of price pressures globally. Of course, it will take many months before runaway inflation fears can be quelled. Drawing a comparison between the MXN 2yr bond yield and the US 2yr bond yield, both are gradually climbing back from record lows, trading around 6.63% and 0.40%, respectively. As such, the yield spread between the two tenors has accelerated this week to trade around 635bps, returning to levels last witnessed back in March last year. Looking ahead, we could see the spread widen further towards last year’s high of 660bps and return to pre-pandemic levels.

Colombia: The Colombian yield curve continued with its recent flattening bias on Wednesday, with yields rising marginally at the belly of the curve, and falling sharply at the long-end. The strong demand for longer-dated tenors reflected strong risk appetite through the session, as well as rising oil prices and the expected impact thereof on Colombia's growth and fiscal outlook. Market steadiness at the short-end, meanwhile, pointed to contentment with positioning for more aggressive BanRep rate hikes in the months ahead, even after recent data suggested economic tailwinds may be waning. Looking ahead, inflation fears and the impact thereof on prospective monetary policymaking, together with oil-market dynamics, will likely continue to provide the market with directional cues in the near term. .

Chile: The IRS curve continues to consolidate after paring back off the recent highs. Payers have had an exceptionally good run. The 10yr is 172.20% higher versus its lows over the last year. A low of 2.2575% was recorded at the start of Nov 2020 and the high of 6.1450% was posted on the 12th Oct 2021. In terms of the curve shape, 2v10 is holding north of the 65 bpt mark which proved to be the line in the sand for now. Bonds remain volatile as investors assess the broader risks associated with the local debt markets. Political as well as fiscal risks abound

Peru: The rebound for local government bonds was short-lived on Tuesday as the market came under some pressure yesterday, with political concerns likely at play here after Congress approved the measures that strip Castillo of some of his powers regarding dissolving Congress. This was a reminder that even after the positive cabinet reshuffle, political risks remain high in Peru and will continue to leave a notable amount of risk embedded into local bonds. Given this and current yield levels, the upside for Peruvian bonds may be limited over the near term.