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Article / 24 August 2016 at 10:00 GMT

Weekly Bond Update: Brazil's Olympic hangover

Fixed Income trader / Saxo Bank
  • Brazil facing reality after Olympics party over
  • Hope that Rouseff impeachment is catalyst for better investor environment
  • Manufacturing PMI rebounds after dismal May reading
  • Brazilian bonds rally gathering powerful momentum

Now the games have gone, what's the reality for Brazil? Photo: iStock

By Michael Boye

Despite a rather tumultuous build-up, the Rio 2016 Olympic Games went ahead reasonably well, with fewer hiccups than probably most had feared beforehand. For the ordinary Brazilian the Games offered a pleasant diversion away from the otherwise more gloomy reality of a prolonged economic recession and a political system in shambles.

But while spirits may still be running high for many Brazilians after the dramatic penalty shoot-out win in the Football final, as the games are now over, its back to the daily grind where reality awaits.

Already by Thursday, the impeachment trial against suspended president Dilma Rouseff will begin, and as our regular readers will be well informed of, its outcome could very well set the direction for Brazil both economically and politically for years to come. The still-in-office president will be facing charges over doctoring the national budget, and her chances to survive an ousting vote are slim to none given the more than sufficient senate majority which chose to indict her in the first place.

However, in the middle of this Olympic hangover and political impasse, things could be on the verge of turning for the better. Following her initial suspension in May this year and subsequent replacement by Michel Temer, investor optimism has returned strongly - just as had been anticipated by the market. Manufacturing PMI, which is tracking sentiment among purchasing managers, has increased to index 46 from the bleak 41.6 reading in May, while industrial production rose in June for the fourth month in a row.

Credit investors have seen a remarkable rally in Brazilian bonds this year as a result. The 5-year USD CDS, a proxy for default risk, has dropped from 500 bps to 254 bps. Brazilian 10-year government bonds denominated in USD now yields 4% down from 7,4% at the high. Corporations have seen similar improvements. As late as on May 23 the national oil company and corruption scandal hotbed Petrobras paid 8,75% for new 10 year USD debt, but this bond is now trading north of a 110 price and a 7.2% yield.

 Brazilian default risk has increased this year as PMI indicates economic rebound
Source: Bloomberg

As the chart reveals, there is still plenty of upside potential if conditions continue to improve and compared to developed market returns, investors may still find the current yield levels very intriguing. A prerequisite though will be the final ousting of Rousseff, as well as the ability of Temer to deliver on reform promises.

So far, 
its been plenty sufficient for the temporary caretaker to just not be his predecessor, but going forward investors demand a real clean-up of the corruption that has been plaguing the country for decades.

— Edited by Martin O'Rourke

Michael Boye is on the fixed income desk at Saxo Bank


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