Last night the political chaos in Brazil hit new levels when Federal Judge Sergio Moro released wiretap recordings between current President Dilma Rousseff and ex-President Lula. Some of the recordings were from earlier that same day, and appeared to be timed to coincide with Lula’s appointment to a ministerial position (thereby shielding him from Federal prosecution) and create maximum damage to the government. The result was a dramatic increase in political tensions and an existential challenge to Dilma Rousseff’s presidency. And that means that investors will be eying another rally.
At least one local brokerage house this morning sent out a report to clients that suggests that bad news for the current administration – which is under even more pressure than it was following last Sunday’s massive protests – will be good for the markets.
We have seen this before. Between the end of February and March 11 the currency and the Ibovespa rallied on the news that the Lava Jato investigation had began to close in on Lula, imperilling the current government. This led to a strong rally – the Ibovespa climbed 27% in dollar terms (the real hit 3.58 from 4.0 in the same period).
With Brazil’s economy currently pricing in the biggest recession in a century as well as political deadlock, investors are keen not to miss the point of Brazil’s long-term rally. Asset prices and FX could potentially both rebound sharply, making Brazil an unmissable trade – when it bottoms out. Bloomberg reported that the rally in early March was sparked entirely by positive foreign inflows of $1.6 billion.
However, it is highly unlikely that this is the entry point. Even if Rousseff is impeached, the political statement will last for months and the outcome would be uncertain, controversial and possibly heighten the country’s already-high political and social divisions.
If the electoral court (another legal challenge to the current government) rules that the last election invalid (because campaign funds have been linked to the Petro bras corruption scandal) new elections will be called – but who would win? The last presidential challenger, Aecio Neves (PSDB), has been implicated in the corruption scandal. As has Michel Temer (PMDB), who would become acting president if Rousseff is removed should the formal impeachment process begin. Around 70 current lawmakers have been implicated in a recent plea-bargain statement by a senior member of Rousseff’s administration, Senator Delcidio do Amaral.
When Aeico Neves joined last Sunday’s protests he was heckled and taunted. He lasted 30 minutes before beating a retreat.
The anger in the country is focused on the current government and the PT but spills over onto all lawmakers. There are currently 28 political parties in the Brazilian parliament – and this number is likely to proliferate rather than diminish with fresh elections.
Under any likely outcome to the current impasse, the country is likely to remain ungovernable. Ungovernable in the sense that Brazil will have a president that has a majority or stable coalition and the political capital and will to introduce the painful fiscal reforms (among others) that the country requires to get it back to a path of long-term, stable growth.
And yet the market still seeks short-term rallies. Yesterday, a rumour whirled round traders in the Bovespa that Henrique Meirelles was going to replace Alexandre Tombini as president of Brazil’s Central Bank. The index soared from an intraday low of nearly -1% to close up 1.34%. Meirelles has an excellent reputation and track record but a name-based rally misses the point that monetary policy isn’t really the problem. The economy’s true weakness is bleeding fiscal accounts: runaway fiscal spending – with potentially more to come should Lula’s hold on economic policy come to fruition as many political analysts expect (Lula is rumoured to be mulling using FX reserves for huge infrastructure spending as well as trying to re-light the consumer credit fire through fresh loans delivered by the state-owned banks).
Economists say that the recent rallies in the real already make it over-valued – despite its long-term slide since 2011. RBC calculates that fair value is around $4.30, and that level is being eroded monthly by the country’s high inflation. RBC expects the currency to drift to R$5.00 to the dollar by the end of 2015.
However, political developments will again lead to short-term rallies. Already this morning, before the markets have opened the real has jumped to R$3.66 from closing yesterday at R$3.74.
If investors are looking to trade short-term rallies there is potentially money to be made. But if your outlook is longer – and especially if it is dollar denominated – entering Brazil now is not a trade for the brave, but for the foolhardy.