A Car Wash for Brazil?

June 09, 2017

Many EMD strategies hold overweight positions to Brazilian sovereign and corporate bonds, in both hard and local currencies.  These overweight positions have rewarded investors over the past year as Brazil led the overall emerging markets debt (EMD) space in spread tightening, helping drive double-digit returns for the asset class.  This was primarily due to renewed optimism after the impeachment of former Brazilian President Dilma Rousseff.

However, the possibility of two presidential impeachments in Brazil within a year has arisen over the last few weeks as news circulated that the Chairman of the world’s largest meat company has taped conversations of new Brazilian President Michel Temer discussing bribes related to Operation Car Wash.  Operation Car Wash involves officials at Petrobras, Brazil’s main semi-public petroleum company, allegedly taking bribes for awarding contracts to construction companies at inflated prices.  Temer denies any wrongdoing.

At least temporarily, this latest controversy threatened to derail the positive momentum from Brazilian bonds.  As shown in this week’s chart, spreads spiked during the news broadcast of Temer’s allegations, but have retreated back to the previous tights of earlier this year as the market is apparently confident that Brazil’s economy can sustain another impeachment or that impeachment is unlikely.  Of course, all EMD asset managers will continue to assess and adjust their positioning based on their interpretations of fundamentals, value and technicals.  In spite of this recent news from Brazil, we recommend maintaining EMD holdings for the time being.

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