Latest thoughts on Brazil (and EM) - BBH

Marc Chandler, Global Head of Currency Strategy at BBH, argues that Temer’s presidency is in jeopardy, as is the crucial pension reform bill. He further adds that the markets opened in panic mode, but have since calmed after circuit-breakers were triggered, but we see further losses ahead.

Key quotes:

"Local press reported that meat-packing company JBS has submitted compromising tape recordings to the Supreme Court.  They reportedly have President Temer approving “hush money” payments to jailed former lower house Speaker Eduardo Cunha.  Temer denies any wrongdoing, but many observers (including us) have long felt that it was only a matter of time before the ongoing “Car Wash” corruption scandal implicated him."  

"If the recordings are true and released to the public, we see no way that Temer can survive as president.  Some opposition parties are already calling for Temer to step down.  If he does not, then the opposition will push for an impeachment trial.  Some are even floating the idea of annulling the 2014 election.  Fresh elections are not due until 2018."  

"We think it’s safe to say that if Temer is forced out, the economic reform agenda is dead in the water.  The pension reform vote has already been suspended.  Many were looking for a late May/early June vote, but now it remains to be seen whether a vote will ever be held.  While the situation remains fluid, we think it’s safe to say that markets should be braced for more bad news ahead from Brazil."

"The real has come under significant pressure today.  BRL futures trading on the BM&F was initially halted by a 6% limit up for the first USD/BRL contract.  The limit was temporarily raised to 9% for today only, but that circuit-break was also triggered.  With the central bank offering 40k swaps contracts today, FX markets have calmed and some BM&F trading has resumed.  However, bid-offer spreads remain wide across Brazilian FX markets."

"USD/BRL trading at 3.10 was predicated on successful passage of pension reform and other structural reforms.  That is no longer the base case.  As we’ve long complained, 3.10 was pricing in perfection.  Now, in this imperfect situation, the big question is where should it trade now that this basic assumption of perfection has been turned on its head?"

"Indicative pricing shows spot USD/BRL high at 3.41 today, though transactions have been extremely limited.  The November/December high near 3.50 seems like a reasonable target.  However, a clean break of the 3.41 area would set up a test of the May 2016 higher near 3.64."

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