May was not an easy month for emerging markets in general and for Latin American currencies in particular as investors focused on the implications of US monetary policy tightening, as well as the pace of US inflation, causing a shift from riskier assets to 'safer' investments and sending Latin American currencies, notably the real in Brazil, lower.
The Brazilian currency reeled after the central bank did not deliver an expected 25bp cut in the SELIC rate, currently at 6.5%, a move seen as hawkish. Market volatility and investor apprehension rose further as a truck drivers’ strike over fuel price increases paralysed Brazil’s entire supply chain and cargo transport. A measure of calm returned after a late-May agreement with road hauliers with some minor points of conflict remaining.
Brazil government negotiates price cut... or did it?
The fuel price pressures reflect the end of subsidies, oil price increases and the real's weakness.
Subsidies paid by state-controlled Petrobras (the same energy company that was at the centre of the Lava Jato corruption scandal) kept a lid on domestic petrol costs and shielded consumers from movements in international energy prices - but created an enormous debt burden at Petrobras - until two years ago when President Michel Temer ended the cap.
However, the recent rise in international oil prices combined with turbulence in emerging market currencies pushed down the real, causing domestic fuel costs to rise, truckers to go strike in protest and Brazil to gradually grind to a halt.
As part of the agreement between the government and the truckers, President Temer announced a diesel price cut for 60 days, at a cost of around BRL 9.5 billion to the federal budget (equivalent to USD 2.6 billion) as the state compensates Petrobras for any losses.
Petrobras CEO Pedro Parente disputed that the government asked Petrobras to change its fuel-price policy and insisted the company would not cut prices. There is now a question of to what extent the federal administration can interfere in the affairs of state-owned companies. This subject will be watched closely in coming weeks.Exhibit 1: Latest developments in Brazil's financial markets Source: Bloomberg, BNP Paribas Asset Management Brasil, as of 29/05/2018
Brazil markets slide over curve steepening, central bank volte-face
The Ibovespa equity index lost almost 11% over the month (in local currency terms) as the real skidded on the steepening of the yield curve after the central bank’s decisions to stand pat. It was dragged down further by the fall in Petrobras stock. Blue chips such as Itau, Bradesco (banks) and brewer Ambev fell significantly in a sell-off driven mainly by domestic investors (hedge funds). Typically, they are big traders of high-beta, liquid indices.
In Brazilian fixed-income markets, the yield curve steepened. Short maturities corrected as the expected 25bp rate cut was priced out and 10-year sovereign debt yields rose by 200bp. The US dollar appreciated by 6% against the real, partly contained by significant intervention by Brazil’s central bank to reduce the currency’s volatility.
There has been considerable discontent regarding the Brazilian central bank‘s communication. It had indicated a rate cut was imminent, then made a volte-face. At the same time, market concern remains over Brazil’s fiscal health after the government’s recent concessions. These factors explain the spike in bond yields and volatility.
Among the silver linings, we highlight the solid performance of Vale (mining), which was pushed higher by the strengthening of global commodity prices, and Suzano and Fibria (pulp & paper). Both are exporters and should benefit from the depreciation of the real.More posts on emerging markets More posts on Brazil
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