Brazil and Argentina: reform hopes rising… for now

The sharp rallies in the Argentine peso and Brazilian real reflect growing optimism that economic policymaking will improve in both countries, but markets seem to be looking through the political hurdles to reform that are building. While Argentina’s IMF deal has alleviated near-term default risks and prompted tighter policy, the public backlash against austerity seems to be building. As we’ve warned before, this could result in fiscal slippage by the Macri government (and stoke tensions with the IMF) ahead of next year’s elections, or even a new left-wing government. Investors in Brazil seem to be overlooking the fact that, as Jair Bolsonaro has closed in on the presidency, he also seems to be backtracking on his reform pledges. We expect the real to suffer renewed falls, and local currency bond yields are likely to rise.