Trading A Presidential Impeachment: Brazil Edition
Well it finally happened. Brazil impeached President Dilma Rousseff. Sort of.
Technically, the Senate voted to move forward with the impeachment process, which means Rousseff will stand trial on charges she conspired to cook the fiscal books in 2014. Meanwhile, VP Michel Temer will govern. He’s expected to announce his cabinet later today.
For those who haven’t followed the story, this is a big deal. And not just from a political perspective. Brazil is Latin America’s most important economy. The country also put the “B” in “BRICS.”
Brazil is mired in a protracted downturn that looks more like a depression than a recession. Inflation is running close to 10% (IPCA printed at 9.3% Y/Y last month), unemployment hit double-digits this year, and growth has simply collapsed. In other words: the stagflation that took hold in earnest last summer isn’t showing any signs of receding.
(Charts: Deutsche Bank)
I’d be remiss if I didn’t give a brief rundown of the political backstory - context is critical here and besides that, Brazilian assets and the USDBRL cross trade almost exclusively on politics.
Nearly a fourth of the country’s lawmakers face active criminal investigations. The impeachment committee reflects that reality. Indeed, Lower House Speaker Eduardo Cunha - Rousseff’s main political opponent and ringleader of the impeachment bid - was ousted last week on corruption charges.
Quite a few of the open investigations relate to the Carwash probe, a sweeping effort led by federal judge Sergio Moro who has made quite a name for himself in the course of his crusade to root out bid-rigging and other corruption at Petrobras, where Rousseff was once Chairman. I won’t delve too deeply into the details, but suffice to say that it all came to a head in March when Rousseff sought to shield her mentor, former President Luiz Inácio Lula da Silva, from the investigation by offering him a ministerial post. Moro was having none of it. The judge tapped Rousseff’s phone and released incriminating records of the calls. That was the last straw for many Brazilians and for many opposition lawmakers.
As mentioned above, you should care about this as an investor, but also as a trader. Anyone who understands the ebb and flow of the political process in Brazilian probably could have made a small fortune in March trading in and out of markets. Stocks and the BRL traded almost exclusively on political headlines related to Lula’s detention and the subsequent controversy over his appointment to Rousseff’s cabinet.
Despite the abysmal economic backdrop (which many Brazilians “credit” Rousseff for creating), it’s been a good year to be long Brazilian stocks. Brazilian equities are up more than 20% this year.
Meanwhile, the BRL is the world’s best performing currency. Early Thursday, the currency was pushing towards a YTD high of 3.43 before weakening. The currency has been so strong in fact, that the central bank has been forced to sell reverse swaps in order to prevent the decisively unpalatable scenario wherein the currency is unable to do its part in helping the economy adjust. CDS spreads have come in as well:
(Chart: Deutsche Bank)
Why the optimism in markets? Simple: anything, investors reason, is better than Rousseff.
The margin in the Senate vote - 55 in favor of impeachment - was wider than expected Amundi Global Emerging Markets Strategist Abbas Ameli-Renani told Bloomberg on Thursday. “It’s not priced in by the market,” he said, adding that this will be a “further positive impetus for Brazilian assets.”
Supposedly, VP Temer’s policies will help clear up the nation’s fiscal woes. Here’s BofAML’s take:
“We forecast a new macro scenario under interim president Michel Temer’s government, as we expect his administration to have more support in Congress, given the votes in favor of the impeachment in both Houses. Better governability should help the new government approve needed economic and fiscal measures, which could result in better prospect for fiscal accounts in the future. This, combined with a decline in the political uncertainty, should lead to better confidence levels, opening room for a rebound in economic activity.”
Only not right now:
“As a pickup in confidence levels usually leads to an increase in GDP two quarters later, we do not see much impact on 2016 GDP under this scenario and maintain our forecast for a 3.5% contraction.”
It’s impossible to say with any degree of certainty how the politics here will play out. And that means there are likely to be plenty of trading opportunities ahead.
But exercise caution. This isn’t for the faint of heart. While Brazilian stocks have been a big winner this year, it’s worth noting that quite a bit of the money coming in was from foreign investors, which could mean the locals don’t have much confidence that things are going to turn around from an economic perspective.
As far as the BRL is concerned, you’ll need to mind the BCB. As mentioned above they’re auctioning reverse swaps to keep a lid on “excessive” appreciation which means anyone looking for gains is playing tug of war with a central bank that still has more than $60 billion in outstanding swaps it can buy. Indeed it’s entirely possible that the currency has overshot and may do so again as the impeachment process plays out.
Trade accordingly.
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