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) |
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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 |
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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 |
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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 | 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 | End 2021 | End | 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