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Analysts at Rabobank suggest that the reduction in global risk appetite caught the Brazilian economy only halfway prepared, as the recent sell-off in national assets can tell.

Key Quotes

“If on one hand inflation readings, expectations are in-line with target and the external position is solid – with low current account deficit, hefty direct investment, huge FX reserves – on the other hand the opposite is true when it comes to the fiscal situation.”

“We continue to see the approval of macro reforms and maintenance of an orthodox policymaking as necessary conditions to stabilize government debt, consolidate the convergence of inflation and interest rate to international levels, and generate sustainable growth.”

“In our view, these elements make this year’s general election the most important conditioner for the outlook of Brazilian economy and markets. Now even more so amid such less friendly global conditions. At this stage, however, the political scene still looks very fragmented and the outlook for the presidential race still looks quite fluid.”

“Uncertainty about this year’s general elections is to set a (possibly greater) toll on the economy, as it contributes further to worsen financial conditions, already hit by a globally led rout.”

“Under our (increasingly challenged) baseline assumption of a reformist administration taking office next year, we expect declines in Brazilian risk premia and BRL appreciation towards 3.70/USD (down from our currently estimated short-term fair value of 4.10″¦as BCB’s FX swaps will likely unwind).”

“In opposite direction, a populist (or anti-reformist) macro agenda would lead to massive idiosyncratic deterioration in Brazilian assets (e.g. FX rate through 5.00), de-anchoring of inflation expectations, loss of confidence by business and consumers and another recessionary tumble.”

“In the next few weeks before the start of the electoral campaign (mid-August), political alliances will shape up and tickets will be formed. The news flows (including developments in electoral surveys) will help determine which way economic expectations and asset prices will head before October.”