In the midst of a turbulent first quarter of 2016, emerging market currencies have had their best performing month in 18 years this March. The top performers are the Russian rouble and Brazilian real, up 11.2% and 10.4% respectively versus the dollar. The Argentine and Colombian pesos, Korean won, Malaysian ringgit, Polish zloty and South African rand were amongst other currencies that appreciated between 5% and 8% this month also. This of course is a retracement following the 50% rise in oil, back to end 2015 prices, and a more dovish tone from the US Fed. But should Brazil really be the one of the leading performers on the back of all these developments? Are markets assuming these factors have considerably more impact than the escalating internal strife? Of course Brazil stands to benefit from these latest developments and a settling of exaggerated Fed rate rise expectations. But the country is still in the middle of a major political upset at a time when it really needs to be addressing public spending and economic reform in the face of stagnating growth.
The questionable actions of Judge Sérgio Moro, in releasing an indicting phone conversation between President Rousseff and (the once people’s hero) former President Lula, has swayed the vast majority of Brazilians to call for Ms Rousseff’s impeachment, barred Mr Lula’s appointment as chief of staff, caused as many as 3m protesters to take to the streets and led the Brazilian Republican Party to sever their coalition with Ms Rousseff (with The Progressive Party likely to do likewise). Yesterday, PMDB the largest party also quit the ruling coalition. This now makes it highly unlikely for the president to attain the necessary votes to avoid impeachment. Such a progression could happen in April and see Rousseff removed from her seat of power immediately for 6 months of Senate deliberation. Such a focus on political reforms and seat filling clearly does not come at an opportune time and severely restricts the capacity for the also needed economic reforms. Vice President Michel Temer is likely to lead the subsequent divided government until 2018 and is unlikely to have sufficient backing to address real and present issues like the double digit deficits, public debt above 70% of GDP and GDP which is expected to shrink by 4% this year having shrunk that much already in 2015.
Investments in Brazilian local and dollar paper, as well as in other emerging markets investments, have performed well over the past 6 weeks, but moving forward we anticipate some further differentiation between vulnerable higher yielding paper and attractive risk adjusted higher yielding bonds. With the Brazilian real back to a 3.6 level not seen since August 2015 (when oil was $50 a barrel and President Rousseff’s approval ratings weren’t in single figures) and 10 year Brazilian USD paper yielding under 5.5% we believe Brazil is in the former category of vulnerable higher yielding paper. Within the LatAm space prefer the much more dull opportunities in Mexico where you can attain Baa1/BBB+ quasi-sovereign Pemex paper with similar yield and duration as the Brazilian Ba2/BB paper. Mexico remains much more closely partnered economically with the US and Canada and does not rely so heavily on commodity exports, has an attractively priced labour force and is not facing a political cataclysm. We believe that value and attractive yields can still be found across the global and emerging market investment grade bond space but stress how important discrimination for real value is. The current scandal in Brazil is far from being resolved and (as the Brazilians say) has little and decreasing chance of “ending up in pizza”.