Temporary Relief in the Markets
The election of Biden in the United States and the news about the pending approval of effective vaccines against COVID 19 have increased investor’s risk appetite throughout the world. This has caused a generalized upward movement of stock prices, including in Brazil. The optimism over the vaccine has not totally eliminated the fear that the second wave of contagion in Europe will transform the V-shaped recovery into one with a W shape. It also has not obscured the fact that despite the huge monetary stimulus given by the Federal Reserve, recovery in the USA remains fitful and needs a significant fiscal stimulus as well. Brazil is also starting to see a second wave in the states of the South and Southeast regions and is still plagued by the lack of definition by the government about the fiscal policy path that will be followed in 2021. Congress has until the end of December to approve the budget bill for 2021 and the proposed constitutional amendment (PEC) to establish triggers in case of risk of failure to meet the spending cap. Other than a timid administrative reform proposal that would not check the growth of civil servants’ salaries in the coming years, there are no reform bills close to being approved. In summary, the government has basically been inert against a backdrop of a worsening fiscal situation, meaning that the increase in asset prices in Brazil prompted by the more favorable international environment will only be a passing phenomenon.
The fair winds blowing in the international scene have helped the price of Brazilian assets. The real ended last week quoted at R$ 5.36/US$, a gain of nearly 2% in relation to the previous week, and 7% stronger than at the end of October. The yield curve has also become slightly less steep at the long end, but at the short end (0 to 12 months) there has been a significant increase of the positive slope, reflecting an increase in the likelihood the SELIC rate will be raised at some point in 2021 (Graph 1). Although the exchange rate has strengthened slightly, from R$ 5.60 to the neighborhood of R$5.30 to R$5.40, nothing guarantees the currency won’t weaken again as new information becomes available about the fiscal situation. Our model of the real exchange rate indicates that in September, the rate was 16% more depreciated than indicated by the model of its fair value, which is estimated in function of the terms of trade and the net external liability (Graph 2). This discrepancy indicates overshooting only slightly less than what happened in 2002 during the transition from the FHC administration to the Lula government, when the EMBI-Brazil (equivalent to 10-year CDS) climbed to a dizzying 2,400 points. The greater slope of the yield curve and depreciation of the real provide a manifestation, in the form of risk premiums, of the fiscal risk. Since we don’t see any urgency from the government regarding approval of the necessary reforms to establish a solid fiscal anchor, we have to warn that the recent “improvement” of asset prices will very likely be fleeting...
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