Brazilian Tremors

What Happened?

A year after ex-President Rousseff was impeached, Brazil's latest President Temer is suspected to have been caught in a political scandal. The O Globo newspaper revealed yesterday that it has evidence that Temer authorised a bribe to silence a politician serving jail time for corruption in the huge Petrobras scandal.

Opposition parties swiftly took the opportunity to call for impeachment. Temer denied the allegations and responded with a refusal to resign.
 

Market Reaction

The market in Brazil took a severe hit. Equity markets plunged 8.8%. The BRL dropped 7.8% against each of the EUR and the USD. 10-year sovereign bonds lost 3.8%. Despite the local nature of the scandal, other Latin America markets took a hit, to a much lesser extent obviously, as general sentiment deteriorated.
 

Analysis

This latest crisis arrives at a time when Brazil is implementing structural reforms, notably on labour regulation and its social security system. It is difficult for the moment to assess the real threat of this most recent political scandal on the country's ability to continue its long-awaited reforms.

We turned positive on emerging bonds in local currency two weeks ago. With Brazil representing 10% of the index, the positive returns accumulated so far were unfortunately wiped out in a day. However our fundamental view on the asset class has not changed. The index is diversified and the contagion to the some other emerging countries should be limited and not last.

Regarding Brazilian equities, our negative recommendation is maintained. We wait for better growth and a more favourable political climate. Even after this setback, valuations still look expensive (P/E at 11.5x vs. 10.9x for 5yr average).