Americas Economic Update

Investor sentiment in Brazil has been hit by rising political tensions and concerns about the recovery and public spending in Latin America’s largest economy.

In recent weeks, the country’s currency and stock exchanges have come under pressure amidst conflicts between Jair Bolsonaro and senior judges over the president’s unconfirmed allegations. Voter fraud allegations.

This week’s rebound did not completely reverse the decline. After a period of relative calm, the real exchange rate against the U.S. dollar rose to 4.91 in June, after which the currency’s exchange rate against the U.S. dollar has fallen by about 6% to 5.25.

At the same time, the Ibovespa stock index has fallen by nearly 9% since hitting a record high 11 weeks ago, although in local currencies and U.S. dollars, it has risen slightly so far in 2022.

Pablo Riveroll, head of Latin American equities at Schroder, a London asset management company, said: “This month is not a good month for the emerging markets as a whole, but Brazil has clearly seen greater Degree of risk increased.”

“Brazil’s initial performance this year was actually very good, and now after the recent sell-off, it has lost [other] EM”.

Although external factors such as the global spread of the delta variant of the coronavirus and pressure on certain commodity prices have played a role, market participants said that domestic issues are the main driving factor.

Paulo Bilyk, chief executive of Rio Bravo Investimentos, which manages 13 billion reais of assets, cited the weakened political status of the government.

“They have been very difficult in power, and their mistakes mean that their popularity has been declining. Therefore, our speech and behavior have become more and more radical. These are not good for the market.”

In addition to making an undisguised threat to next year’s presidential election, Bolsonaro also promised to increase payments under a reformed welfare plan for the poorest people in the country as his approval rate drops.

This raises concerns that the populist government may not respect the constitutional spending ceiling to prevent the budget from increasing beyond inflation. Given Brazil’s already high public debt level, this is an urgent priority for investors. 84% GDP.For many people, this is better than political turmoil.

“We think the risks surrounding fiscal discipline are higher in the future. This also puts pressure on the currency,” said Júlia Gottlieb, an economist at the local bank Itaú Unibanco.

The rise in government borrowing costs proves this: the yield on 10-year local currency bonds recently reached the highest point since the 2018 presidential election.

The bond’s current yield is about 10.3%, slightly lower than last week’s high of over 11%, but much higher than the level of about 7% at the end of last year.

10-year yield (%) line chart shows that Brazilian debt is facing selling pressure in 2022

The central bank is seeking to combat inflation. The 12-month inflation rate as of July was 8.99%, higher than the 2022 target of 3.75%. According to a survey conducted by the Central Bank, it has raised the benchmark Selic interest rate from a historical low of 2% to 5.25%, and the market expects it to reach 7.5% by the end of this year.

More expensive financing costs often affect stock valuations and economic activity. According to the central bank’s survey, although GDP growth this year is expected to exceed 5%, the forecast for 2022 is steadily declining.

The cash transfer program surrounding the new plan and the development of next year’s budget, as well as possible changes in the tax reform bill and court-ordered public debt payments, may have a significant impact on investor sentiment towards Brazil in the coming months.

Cassiana Fernández, chief economist at JPMorgan Chase Brazil, said that these variables “will be closely monitored by the market to assess the government’s willingness and ability to at least partially restore the credibility of sustainable economic policies.”

She added: “We hope [the real] It remained quite volatile and was close to 5.40” at the end of the year.

Additional report by Carolina Pulice in Sao Paulo

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