“People like buying into good stories”, said Jan Dehn, head of research at emerging-markets specialist Ashmore Investment Management. Believe it or not, but Dehn is talking about Brazil here, a country mired in its worst recession since the 1930s which has seen government debt skyrocketing over the past three years.
But because markets tend to overreact, all bad stories have the potential to turn into good ones, says Dehn. “Brazil is an incredibly compelling fixed income story. It’s the best performing fixed income market in the world this year.”
Inflation has stopped rising, as the mid-month IPCA-15 inflation index decelerated from 9.95% year on year in March to 9.34% year on year in April, while core inflation fell too, said Dehn.
Meanwhile, the current account deficit narrowed to just $0.9bn in March, which was lower than anticipated ($1.2bn). Foreign direct inflows over the past twelve months have remained solid and now stand at $78.9bn.
The downturn in inflation, improving external balances and President Dilma Rousseff’s ongoing impeachment process, all strongly support the fixed income market in Brazil this year, in Dehn’s view.
Many hurdles left to take
But not everyone’s views are as rosy as Dehn’s. “While the vote was an important step, we expect the impeachment trajectory will be bumpy and lead to volatility in Brazilian bond markets in the coming months,” said Rob Drijkoningen, co-head of the emerging market debt team at Neuberger Berman. “Not only is the process likely to take several months with three more voting rounds in the Senate, but there are also question marks surrounding potential successors and policies.”
“Vice President Temer is under scrutiny himself over claims he was involved in an illegal ethanol purchasing scheme and could also face an impeachment procedure. Furthermore, protests from supporters of Rousseff’s Workers Party and potential union-led strikes are likely to spark further turmoil in the country,” he continued.
Despite the political uncertainty Neuberger Berman has been overweight Brazil across its portfolios, based on the view that the risk premia more than compensates for the deteriorating economic fundamentals, especially considering the relatively low levels of external debt and high international reserves.
“We also have an overweight to local rates in Brazil, as we expect inflation to come down from the recent peak. This is driven by weak growth and more stable FX levels, while high real rates offer an attractive risk premium even if compared to the sovereign risk premium,” said Drijkoningen.
But Neuberger Berman has been trimming those overweight positions in recent months, taking some profits as Brazil bond markets rallied and the valuation premia declined from recent highs factoring in the likelihood of impeachment. “Events in the coming months are likely to result in further volatility in Brazil bond markets, which justifies a limited risk position at current levels,” said Drijkoningen.