The Brazilian short-term rollercoaster

It’s hard to fight that the driver of the recent downturn in the Latam markets and increase in volatility was triggered by something different than external factors. The hawkishness of the FED at the beginning of the year led the US rate to the so feared psychological level of 3%. The biggest question we then started receiving by our clients is “Now what?”

The EM currencies have clearly incorporated this “new level” of US rates and some of the risk off mode that the market showed with the increase uncertainty of the trade war drama. For Latam currencies, particularly for the Real and the Argentinian Peso the carry trade story unwinded and we saw the debacle. We believe that the external story became internal for Argentina that is now facing an internal crisis from the political perspective and higher inflation with lower growth for the short term. The Brazilian case is somehow different. The Real saw its worst (relative to EM currencies) after the truck strike and the lack of monetary policy response (with is debatable on what was best) didn’t help. Now the Real is at 3.79, far from the levels at the beginning of the year. From now up to the elections, the political news flows should have higher impact in the Real.

We believe that for the Brazilian story to subsist you need two main drivers: growth (mainly through investment) and pension reform.
The main question for the pension reform is: Is it all about politics? We think the answer is no. If you dare to read (its quite extended but interesting) the economic agendas of the main candidates you will get surprised that all of them include up to a certain degree the three main aspects of the pension reforms: age of retirement, transition rule and the equate for private and public employees. The key point here is that it’s finally incorporated in the political agenda the urgency of this reform, even for the most populist parties. We do not think this is incorporated whatsoever in the market. However the market is myopic and in the short term returns will not be driven by pension reform rather by the electoral race.

In the political front the news flows is actually pretty good. Alckmin had an important victory after claiming the support of the center parties (Centrao). He will get 45% of all TV time now. It’s hard to say who is going to win; we still have to see whom is the PT going to put and how this political machine is going to work. We seriously doubt they will fail to get to the second round. So put an eye on Bolsonaro and Alckmin pair trade for next polls after the TV time starts because this will probably be the most relevant political hint you will get. Will TV time make a difference or is social media the key now in Brazil? We think that Alckim from a political coalition is the only one that we believe has the machinery to fight the PT.

From a growth perspective we also have some good news. There is a new installed discussion about changing the current tax regime lowering corporate tax and starting to tax dividends (there is currently an important loophole). This is a global tendency and the impact on FDI alone could be massive.

The net/net here is that there is a lot of uncertainties in the short terms but from a more long terms view it looks like Brazil is going in the right direction. The question now is when to get in this short term rollercoaster and the answer I’ll leave it to you.