Brazil Holds Rates Ahead Of Election Season Kickoff

While it may still be a bit too early to determine the outcome of Brazil’s scheduled fall election, recent scandals within Brazil’s political economy point to voters being very dissatisfied, and a protest or populist candidate may gain power. This, market analysts say, might have negative implications for a government that needs to engage in necessary and almost urgent reform. It should be noted that it is difficult to read too much into polls until TV campaigns begin later in the summer (August).

Ongoing corruption in Brazil has made large parts of the electorate numb to various scandals, and the impact has yet to be minimized. “It is all having a large impact,” Colm McDonagh, Head of Emerging Market Fixed Income at Insight Investment said in an interview. “The corruption scandal meant that key reform was stalled, meaning a more vulnerable economy, and voter discontent.  As has been observed in other democracies, the possibility of a more radical candidate appealing more than a traditional one is rising quickly, as voters consider that ‘they cannot be worse than what we have’.”

Its central bank (Copom) has taken note. In a scheduled policy meeting this month, Copom held official rates steady and communicated its knowledge of inflationary risk while noting it is poised to act to counter any FX shocks. The official currency, the real, has depreciated significantly in the past month, as markets became nervous about the widening fiscal imbalance and government debt. “The Brazilian currency is getting impacted by the strong dollar and the current negative sentiment around emerging markets,” Shamaila Khan, director of AllianceBernstein’s Emerging Market Debt strategies told Emerging Market Views.

The recent countrywide truckers’ strike and the political turmoil that followed it are going to result in weaker than expected growth across Brazil, analysts explained. However, a recession may not be imminent. Copom also noted in its communiqué that the recovery has been gradual and a new recession is unlikely.

“We do not believe the country is going to return to recession.”–Shamaila Khan, AllianceBernstein

Interest rates are still low relative to historical levels and inflation remains contained. Strong external fundamentals are in contrast to the other two countries that are experiencing volatility (i.e. Argentina and Turkey.)”

The Temer administration’s response to the truckers’ strike was more unorthodox than what the market had been expecting and brought forward concerns about the elections and the policies that a future administration may pursue. This was heightened by the fact that the centrist candidate, Geraldo Alckmin, is not polling well. And broader negative sentiment related to more vulnerable countries within emerging markets, such as Argentina and Turkey also exacerbated market reaction to the developments in Brazil.

So while the corruption investigations have created an anti-establishment sentiment in the country, therefore benefitting less established politicians, it is still too soon to draw too many conclusions on who will emerge victorious in the presidential election.

“It’s too soon to say who will win. The markets would like an individual from the centrist parties to win, someone who would commit to pension reform, which is key for fiscal sustainability, continue the reform agenda and ensure strong governability,” Khan added.