Brazilian politics getting messy, Chile’s FCL and bonds - Capital Economics
Latin America Economics

Brazilian politics getting messy, Chile’s FCL and bonds

Latin America Economics Weekly
Written by Quinn Markwith

The unfolding political crisis in Brazil has continued to put local financial markets under pressure and it’s increasingly difficult to see the political risk premium on asset prices evaporating quickly. Elsewhere, the Flexible Credit Line requested by Chile from the IMF this week probably won’t lead to a significant narrowing of the country’s dollar bond spreads. But history suggests that FCLs help to insulate bonds during time of stress.

Real tumbles as political turmoil worsens

Brazilian financial markets suffered further sharp falls this week as concerns about the political crisis mounted. We looked at justice minister Sérgio Moro’s resignation in detail a few weeks ago. (See here.) The story has continued to run, with a video purportedly confirming Mr. Moro’s allegations that President Bolsonaro tried to interfere in police investigations. Calls for impeachment have grown.

At the time the crisis first flared up, we estimated that it resulted in a political risk premium of about 25bp in the spreads of sovereign dollar bonds. (See here.) Using the same methodology, this now appears to have increased to about 50bp.

This political risk premium could, of course, evaporate quickly, boosting local assets prices, if the political noise died down. Predicting how Brazilian politics will play out is outside our field of expertise. Most political commentary suggests that Mr. Bolsonaro is not on the cusp of impeachment. Politicians don’t want to make the current economic and public health crisis worse.

However, by the same token, it’s hard to see the political risk fading soon. Mr. Bolsonaro’s widely-criticised approach to controlling the coronavirus has led to heated disputes with state governors and caused the resignation of his second health minister in a month today. It’s hard to see these issues fading soon. And with well-respected economy minister Paulo Guedes increasingly marginalised, his possible resignation will remain a risk.

We’ll let the dust settle over the coming days. But it’s looking increasingly likely that our current forecast for the real to end the year at 4.7/$ (vs. its current level of 5.9/$) is too optimistic. And the longer this political risk persists, the more likely it is that the central bank will take further easing off the table (at present, we expect one 50bp cut).

Chile’s FCL could shield bonds from future sell-off

History suggests that Chile’s Flexible Credit Line from the IMF is unlikely to significantly reduce dollar bond spreads in the near term, but it could help to shield bonds from a future bout of risk-off.

Policymakers’ request for a $23.8bn FCL should be approved by the IMF given Chile’s strong fundamentals. But history suggests that the impact on bonds in the coming weeks should be muted. Chart 1 borrows a methodology used in this paper by the Belgian National Bank. The “synthetic” line is a weighted average of other countries’ EMBI spreads designed to mimic the spreads of Mexico around the time it secured its FCL in 2009. The FCL didn’t seem to cause Mexican bonds to outperform in the following months. A similar exercise with the bonds of Poland and Colombia, both of which secured FCLs in 2009 too, yields a similar result.

Chart 1: Mexico EMBI Bond Spreads over US Treasuries & Synthetic Control (bp)

Source: Refinitiv, Belgium National Bank

That said, the FCL did appear to insulate bonds from the sell-off during the Eurozone crisis in 2012 (again, a similar result is found in Colombia and Poland). So while Chilean bonds are unlikely to outperform in the coming months, they could weather the next bout of risk-off relatively well.

The week ahead

GDP data should show that Chile’s economy held up well in Q1. But output has since collapsed.


Data Previews

Chile GDP (Q1) Mon. 18th May

Forecasts

Time (BST/EST)

Previous

Consensus

Capital Economics

GDP q/q (y/y)

13.30/8.30

-4.1%(-2.1%)

+2.7%(0.0%)

Worse to come in Q2

Chile’s economy held up well in Q1, but a steep contraction looms in Q2.

The main reason why Chile’s economy probably grew in Q1 is because of a weak basis for comparison provided by the protests and strikes in Q4, and the strong rebound in activity in January and February. (See Chart 2.) But activity plummeted by 5.7% m/m in March due to virus containment measures.

Chile’s retail output fell sharply as social distancing measures dragged on domestic consumption and financial conditions tightened dramatically. One crumb of comfort is that Chilean mining activity held up comparatively better, falling by 1.6% on the month, as the copper industry has been largely unaffected by containment measures.

Q2 is likely to be dire. The latest consumer confidence survey data point to a deep fall in consumer spending in Q2. Our best guess is for a 12% y/y fall in Q2, and 5.0% over 2020 as a whole.

Chart 2: Chile GDP and Economic Activity

Sources: Refinitiv, Capital Economics

Peru GDP (Q1) 20-22nd May

Forecasts

Time (BST/EDT)

Previous

Consensus

Capital Economics

GDP q/q (y/y)

+0.5% (+1.8%)

-5.0% (-2.9%)

Contraction in Q1, further pain ahead

Peruvian GDP likely contracted by around 2.9% y/y in Q1, and output is set for a much deeper contraction in Q2.

Activity was quite strong in January and February, but lockdown measures caused a dramatic slump in activity in March. Economic activity contracted by 16.3% y/y. This is mainly because containment measures in Peru have been particularly severe, and more so than in Chile. We have pencilled in a 2.9% y/y contraction for Q1. (See Chart 3.)

Unfortunately, data for April and May are likely to be even worse. The mining shutdown is only being gradually unwound over the course of this month. And severe social distancing measures will continue to hit consumer spending. Our best guess is that activity will contract by around 13% y/y in Q2, and 3.5% over 2020 as a whole.

Chart 3: Peru GDP and Economic Activity

Sources: Refinitiv, INEGI


Latin America Weekly Diary

Upcoming Events and Data Releases

Date

Country

Release/Indicator/Event

Time (BST)

Time (EDT)

Previous*

Median*

CE Forecasts*

18th May

Chl

GDP (Q1, q/q(y/y))

(13.30)

(08.30)

-4.1%(-2.1%)

+2.7% (0.0%)

Chl

Current Account Balance (Q1)

(13.30)

(08.30)

-$2,363m

20th May

Arg

Economic Activity Index (Mar)

(20.00)

(15.00)

-1.1%(-2.2%)

22nd May

Mex

Retail Sales (Mar)

(12.00)

(07.00)

-1.1%(-2.5%)

Mex

Bi-Weekly CPI (15th May)

(12.00)

(07.00)

+0.2%(+2.2%)

Chl

Central Bank Meeting Minutes

(12.30)

(07.30)

Also expected during this period:

20th – 22nd

Arg

Budget Balance (Apr, ARS)

-124,727m

20th – 22nd

Per

GDP (Q1)

(+1.8%)

(-3.9%)

-5.0% (-2.9%)

Selected future data releases and events

25th May

Mex

Trade Balance (Apr)

(12.00)

(07.00)

+$3,392m

Mex

Current Account Balance (Q1)

(15.00)

(10.00)

+$2,486m

26th May

Mex

IGAE Activity Index (Mar)

(12.00)

(07.00)

-0.2%(-0.6%)

Mex

GDP (Q1, Fin., q/q(y/y))

(12.00)

(07.00)

-1.6%(-1.6%)

Brz

IBGE Inflation IPCA-15 (May)

(13.00)

(08.00)

0.0%(+2.9%)

Brz

Current Account Balance (Apr)

(13.30)

(08.30)

+$868m

27th May

Mex

Inflation Report

(18.00)

(13.00)

Arg

Trade Balance (Apr)

(20.00)

(15.00)

+$1,145m

28th May

Brz

Unemployment Rate (Apr)

(13.00)

(08.00)

12.2%

Mex

Central Bank Meeting Minutes

(15.00)

(10.00)

29th May

Mex

Budget Balance (Apr, MNX, YTD)

+26.9bn

Brz

GDP (Q1, q/q(y/y))

(13.00)

(08.00)

+0.5%(+1.7%)

Brz

Primary Budget Balance (Apr, BRL)

(13.30)

(08.30)

-23.7bn

Brz

Nominal Budget Balance (Apr, BRL)

(13.30)

(08.30)

-79.7bn

Chl

Retail Sales (Apr)

(14.00)

(09.00)

(-14.9%)

Chl

Unemployment Rate (Apr)

(14.00)

(09.00)

8.2%

Chl

Industrial Production (Apr)

(14.00)

(09.00)

(+0.8%)

Chl

Manufacturing Production (Apr)

(14.00)

(09.00)

(+0.6%)

Col

National Unemployment Rate (Apr)

(16.00)

((11.00)

12.6%

Col

Urban Unemployment Rate (Apr)

(16.00)

((11.00)

13.4%

*m/m(y/y) unless otherwise stated; † = previous day

Sources: Bloomberg, Capital Economics


Main Economic & Market Forecasts

Table 1: GDP & Consumer Prices (% y/y)

Share of

World1

2009-18

Ave.

GDP

Consumer Prices

2019

2020f

2021f

2022f

2019

2020f

2021f

2022f

Brazil

2.4

1.3

1.1

-5.5

2.5

2.0

3.7

2.8

3.0

3.5

Mexico

1.8

2.2

-0.1

-8.0

5.0

2.0

3.6

3.0

3.5

3.5

Argentina

0.6

1.0

-2.2

-5.0

2.5

1.0

53.5

45.0

35.0

30.0

Colombia

0.6

3.5

3.3

-5.0

4.0

2.0

3.5

3.5

3.8

3.5

Chile

0.4

3.1

1.1

-5.0

6.0

3.0

2.3

3.0

2.3

3.0

Peru

0.3

4.4

2.2

-3.5

5.0

3.5

2.1

1.8

2.5

3.0

Venezuela

0.2

-5.6

-40.0

-25.0

5.0

10.0

19,906

20,000

3,200

1,000

Ecuador

0.1

2.9

0.1

-6.5

3.0

2.0

0.3

-1.0

0.5

0.5

Uruguay

0.1

3.5

0.2

-6.0

3.0

2.0

7.9

9.0

8.5

8.0

Latin America2

6.5

2.0

0.7

-6.0

3.7

2.0

3.4

2.8

3.0

3.4

Sources: Refinitiv, Capital Economics. 1) % of GDP, 2019, PPP terms (IMF estimates). 2) GDP Excl. Venezuela; Consumer Prices Excl. Argentina & Venezuela.

Table 2: Central Bank Policy Rates (%)

Policy Rate

Latest

(15th May)

Last Change

Next Change

Forecasts

End
2020

End

2021

Brazil

Selic Target

3.00

Down 75bp (May ‘20)

Down 50bp (Jun. ’20)

2.50

3.00

Mexico

Overnight Rate

5.50

Down 50bp (May ‘20)

Down 50bp (Jun. ‘20)

5.00

4.50

Colombia

Intervention Rate

3.25

Down 50bp (Apr. ‘20)

Down 50bp (Jun. ’20)

2.75

2.75

Chile

Overnight Rate

0.50

Down 50bp (Mar. ‘20)

Down 25bp (Q3 ‘20)

0.25

0.25

Peru

Reference Rate

0.25

Down 100bp (Apr. ‘20)

Up 25bp (2022)

0.25

0.25

Sources: Refinitiv, Capital Economics

Table 3: FX Rates vs. US Dollar & Equity Markets

Currency

Latest

(15th May)

Forecasts

Stock Market

Latest

(15th May)

Forecasts

End
2020

End

2021

End
2020

End

2021

Brazil

BRL

5.79

4.70

4.50

Bovespa

78,993

89,750

103,750

Mexico

MXN

23.8

23.0

21.0

Bolsa

36,046

38,800

43,200

Argentina

ARS

67.6

90.0

115.0

Merval

40,266

37,000

44,000

Colombia

COP

3,926

3,800

3,700

COLCAP

1,059

1,370

1,610

Chile

CLP

822

800

750

IPSA

3,678

4,250

4,900

Peru

PEN

3.44

3.35

3.20

S&P/BVL

15,188

17,700

20,100

Sources: Refinitiv, Capital Economics


William Jackson, Chief Emerging Markets Economist, william.jackson@capitaleconomics.com
Quinn Markwith, Latin America Economist, quinn.markwith@capitaleconomics.com