The Brazilian bond market has been especially volatile in recent years and continues to affect the global economy in several ways. Brazil’s political and economic climate has been making headlines lately with experts pointing out Brazil’s economic crisis is the worst since the U.S. Great Depression. Inflation is over 10.6% in Brazil and the labor market is contracting, leaving many unemployed or under-employed. In spite of a dismal fiscal climate and bleak economic forecast, the Brazilian bond market appeared to be stronger than ever with a solid showing early this year. Unfortunately, analysts and financial data reveals that the market may not hold.
A weakened currency and political chaos over the past few years are just some of the contributing factors to Brazil’s poorly performing economy. Earlier this year, Barclays Capital analysts pointed out that the economic and fiscal forecast for Brazil has deteriorated in many ways in just a few months. Last year, Brazil’s fixed-rate government notes due in 2025 fell for the eighth day and the local currency, the real, plummeted. In 2015, the currency dropped 25 percent, according to Bloomberg. But in the midst of it all, bond yields increased dramatically.
Countries around the world are feeling the effects of the global financial crisis but Brazil appears to be caught up in a whirlwind of political unrest and economic turmoil with the recent Petrobras corruption scandal and high inflation rates. Unemployment rates continue to jump and the economy appears to be on a downward spiral, making Brazil even less attractive to foreign investors.
Brazil’s plight can be seen dominating portfolio investors’ confidence — even the highest interest rate among major economies can’t retain foreign investor interest in government bonds.
Non-resident ownership of domestic notes has declined sharply since May. Calls for impeachment, graft scandal at a state-run oil company, and plummeting foreign interest lays eyes directly on President Dilma Rousseff. Brazil’s president has indicated her intention to reform public pensions by decreasing retirement age, increase the minimum wage, and reduce government spending. But promises to bolster finances by closing 10 ministries and selling properties to raise liquidity backfired, causing yields on Brazil’s 10-year debt to rise almost 15 percent.
“Brazil is a big combination of bad news at the moment,” said director at currency brokerage Pioneer Corretora de Cambio in Sao Paulo, Joao Medeiros. “Even though returns in fixed-income assets can be robust, volatility is high and the drop in currency spreads concerns among investors.”
After a harrowing 2015, Brazil seemed to show some rebound in early 2016. However, according to Bloomberg, Brazil’s borrowing and selling of dollars to buy currency in a “carry trade” (strategy where investor borrows money at a low interest rate to invest in an asset that may provide a higher return) backfired.
Twenty economic analysts estimate that Brazil should contract by 2.6 percent in 2016. According to a Bloomberg article by Maria Kolesnikova, this will make it difficult for the Central Bank.
“This makes it hard for the Central Bank to stick to its inflation targeting policy. Higher interest rates worsen Brazil’s fiscal accounts and push long-dated bonds at break-even rates. This is what economists refer to as “fiscal dominance”.
Early this year, Brazil’s notes returned the best performance it’s shown in the subsequent year — almost 2 percent — beating out over 60 other nations as tracked by Bloomberg. But the stats may also show that this is a short-lived win due to the country’s continued economic and political struggles.
Latin America is slated to enter a recession unseen since the early 1900s as political anxiety over Rousseff’s impeachment — the result being a bottleneck of fiscal reforms. As Rousseff denies complicity in falsifying fiscal account or receiving campaign monies, and attempts to salvage her political career, her efforts at boosting Brazil’s economy is hindered greatly.
According to figures by TradeEconomics, Szabo was correct in his concerns. Brazil has indeed shown a decline from early this year to May 30, 2016, and by 13.2 percent from May 29, 2016, alone.
Early this year, when optimism was high after a strong showing in Brazilian currency, Viktor Szabo, manager of over $11bn of emerging markets for Aberdeen in London cautiously said, “Brazil sold off massively last year, so it is not surprising that in the absence of further bad news they can rebound.” But he continues, “However, I wouldn’t read much into a one-week performance. Brazil will try to muddle through, so the question is whether markets will allow that. The fiscal outlook remains very grim.”
His statements may have proven to be prophetic, but only time will tell; there is still more 2016 in which to wait and see.