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BRL tumbles amid political uncertainty
Brazilian assets fell sharply yesterday at the market opening in São Paulo as the political uncertainty rose by another notch. The Brazilian real fell more than 7% against the greenback with USD/BRL rising at around 3.3760 compared to Wednesday’s close of 3.1349 after Brazilian newspaper reports about President Michel Temer.
On the equity side, the situation is not bright either as sell-off in Brazilian equities triggered a circuit-breaker that halted trading after futures on the Bovespa crashed 10% at the Thursday open. In one day, the Brazilian stock market erased almost entirely the gains accumulated since the New Year as the Bovespa closed at 61,597 yesterday.
Investors were caught by surprise as the political situation seemed to settling down as the business-friendly Brazilian President successfully managed to ease foreign investors’ concerns. Traders’ panicked reaction sent option’s implied volatility on USD/BRL through the roof with the 1m measure spiking to 24% from 13.5% a day earlier. The 1m 25 delta risk reversal measure, which is the difference between the price of a call and a put, spiked to 5.74%. Despite the fact that Michel tried to reassure markets, financial indicators continued to move in the other direction with treasury yields and CDS exploding.
Investors reacted aggressively to the news therefore we may see a temporary stabilisation of Brazilian assets morning, especially since the global risk-off sentiment is easing with global equities recovering this morning. However, investors are more than accustomed with the Brazilian political landscape and they know that it may take months before an equilibrium may be reached again. Therefore we would remain cautious regarding the BRL’s outlook, even though there will be some opportunities in the short-term.
Greece: Tsipras negotiates on new austerity policies
It has been a while since Greece was at the top of the market news. We consider this is as a key issue for the European Union so we are still monitoring the country. It is now back into recession (printing two consecutive growth negative quarters) despite the massive austerity policies over the last few years.
Pension cuts or the increase in taxes do not seem to be sufficient and the cost of servicing the debt is way too massive so we do not see any positive issue on that. Greece cannot devalue its currency and so it is then forced to devalue internally, for instance its public aid (pensions in particular).
Since February 2015, Greece has repaid €35.4 billion and by the end of 2018 Greece must repay €28 billion (including €2.7 billion of interest). To put that into perspective, the 2016 nominal GDP was €176 billion. The economy must then expand by at least more than 1.5% next year. And next year repayments are less than half of what Greece will need to pay in 2019.
We don’t see how Greece will be able to reimburse this debt as it is clear that the country won’t be able to print a growth above the cost of servicing its debt. In the short-term, everything looks decent on the single currency side but what will happen when Portugal or Spain have issues as deep as Greece. Uncertainties are far from over on the euro side.