Political Risks and EM Assets

Brazil Politics

It was supposed to be a slow morning, with musings about emerging markets (EM) disinflation and the end of the global tightening cycle. However, politics intervened once again. Brazil’s riots on Sunday shocked both in scope and violence, raising multiple questions about political polarization and its impact on governability, growth and reforms – and about the kind of exposure (if any) investors should have in Brazil going forward. This is not the first time Brazil’s institutions have been tested, but up until now they maintained their credibility – and there is a good chance the same will happen after Sunday’s riots too. The congress stood united in condemning violence and disregard for the rule of law. However, what is good for democracy might not necessarily be good for Brazilian bonds. If President Luiz Inácio Lula da Silva (Lula) emerges politically stronger after the riots, he might be further emboldened to push forward his populist agenda. And this policy uncertainty could be a big negative for local assets, even if political tensions subside.

EM Local Bonds Performance

Brazil is not the only LATAM economy, where politics moves bond/asset prices – albeit Brazil is watched very closely because of the market’s size and local bonds’ outperformance last year (despite developed markets (DM) policy tightening). Colombia was on the opposite end of the performance spectrum – unable to recover after the presidential elections and now the only regional economy where inflation is yet to peak, while the current account deficit widened to 6.7% of GDP in Q3. The central bank is under pressure to hike by 75-100bps more at its next meeting, and the market is watching the government’s fiscal performance as a hawk (this includes the smaller fiscal deficit target for 2023).

EM Disinflation

Brazil’s political noise might distract from the country’s (stellar) disinflation track record – the consensus expects headline inflation to moderate to 5.6% year-on-year tomorrow. However, Mexico’s inflation prints definitely got noticed this morning. The disinflation progress is still wobbly, but both core and headline price pressures appear to have peaked. Mexico’s policy rate is 10.5% and positive in real terms when adjusted both by trailing and expected inflation. The central bank’s minutes sounded cautious, but it can definitely slow the pace of hikes to 25bps if the disinflation trend continues. Stay tuned!

Chart at a Glance: Mexico - Another Inflation Peak in EM

Source: Bloomberg LP.