Riots increase investor anxiety over Brazilian politics

There are many similarities between the attacks on the US Capitol on January 6, 2021 and the riots in Brasilia two years later on January 8.

Looking at the January 2020 chart of the S&P 500 stock index, the swoop in seats in the US Congress is almost undetectable. Brazilian stocks rose on his Jan. 9, the first trading day after Sunday’s riots. Such indifference may be misguided. Investors are right to wonder what the lasting impact will be in Brazil.

It is a truism that external factors are more important than domestic factors for emerging markets. For at least the past year, EM stocks, bonds and currencies have been driven by the Federal Reserve like any other risky asset. For most of 2022, EM assets fell as US interest rates and the dollar rose. Over the past three months, emerging market stocks have plunged on the prospect of easier US monetary policy. bull marketIn the case of Brazil, and in many other cases, global commodity prices can be added as a driving force for domestic equities and bonds.

But the domestic situation is also important. Investors have turned their backs on Brazilian stocks since September 2020, when optimism about the country’s post-pandemic recovery faded. Stocks in the benchmark Bovespa index are currently trading at a futures profit of just 7x, 36% below the 10-year average.

Investors, as they have so many times in the past, are alarmed by the massive fiscal stimulus and the danger that it will cause persistent inflation and financial instability. Before Sunday’s shocking events, they said his two-time president of Brazil and former union leader Luis Inacio Lula da Silva is not failing to deliver on his promise of financial responsibility. I was worried.

After Sunday’s events, you may feel that the hard work just got a whole lot harder. Her Verisk Maplecroft, a risk consultancy, said the riots were certain to undermine market confidence in Brazil, “exposing the long-term vulnerabilities of Lula 3.0.”

it depends. In the short term, the riots gave Lula a boost. US President Joe Biden offered solidarity and called for an invitation to Washington next month, and Lula accepted. Many Brazilians resented the televised scenes of vandalism in modernist works of art in Brasilia.

Lula’s political capital is strengthened. His new government is expected in the coming days to present Congress with measures to help offset the $32 billion increase in public spending pushed through Congress by his transition team last month. Investors would be relieved if that happened soon.

Any delay can make them nervous. Goldman Sachs Latino economist Alberto Ramos says the new spending pledge will tip the fiscal balance from an estimated 1.3% gross domestic product surplus in 2022 to a deficit of at least 1.4% this year. said it would help. The ratio of government debt to GDP is 3-4 percentage points.

It would be a major reversal of recent progress. Public debt has fallen from nearly 99% of his GDP in early 2021 to 89% by mid-last year, according to the industry body, the Institute of International Finance.

Larger threats occur in the medium to long term. Lula narrowly won his October elections, showing just how deeply polarized Brazil is. If the economy is performing poorly and growth is indeed slowing this year, he will be more willing or able to push for unpopular reforms, especially those aimed at raising government revenues or cutting spending. will decrease.

Many foreign investors will continue to focus on the Fed and the commodities big picture. Brazil’s central bank has embarked on a tightening cycle by raising its policy rate to 13.75% from his 2%, reassuring many by acting early and aggressively to combat inflation. Also, since July 2020, the yield on his 10-year Brazilian local currency government bond has more than doubled to 12.7%. When interest rates start to fall, bond prices rise.

“People expect Brazil’s central bank to lead rate cuts in 2023, as the rule of thumb is to go with the flow of central bank policy,” said David Hauner, a strategist at Bank of America Securities. Stated. “A lot of investors are putting a lot of money into the deal.”

But much depends on the new government’s full financial plan, which it promises to announce by April. If Lula is seen to steer finances into better shape, investors may be reassured that central banks can cut back sooner rather than later. I will.