Brazil’s key near-term risk is that the emergency aid bill will be approved without compensatory measures. Mexico’s electricity bill raises further concerns about reforms’ rollback.
The approval of the emergency aid bill is the most important near-term driver for Brazil’s assets. Investors are realists, and they understand that the bill will most likely be watered down. What worries them much more is that the bill might be split into two parts―emergency spending and compensatory measures―which will be voted on separately. If the bill is approved without the compensatory measures, Brazil might end up having a wider budget deficit and a higher debt level in 2021, increasing the uncertainty about the spending cap and potentially leading to more aggressive rate hikes by the central bank.
Mexico continues to generate “ok” macroeconomic results―the post-pandemic recovery is taking place, there is no fiscal blowout, the current account shows textbook adjustment (USD17.4B surplus and another upside surprise in Q4), inflation is sticky but not Turkey-like. However, we see more and more dents in the country’s structural framework. The electricity bill prioritizing the state utility was just approved by the lower house, adding to concerns about the sector’s opening, the energy reform reversal and Mexico’s longer-term growth potential.
Slowly but steadily, the higher inflation backdrop is becoming a given for central banks across the globe. The Bank of Korea just raised its 2021 inflation forecast, as the removal of COVID restrictions and the vaccine rollout is expected to lead to stronger growth (especially in consumption and services). The consensus added 25bps of rate hikes in emerging markets (EM) in 2021, and the recent price action in EM fixed income and currencies shows that the market is still uncertain whether higher rates will “neutralize” the positive impact of the improving growth outlook and higher commodity prices.