Brazil Kickstarts 2017 With Surprise of Aggressive Rate Cut 2

What do falling yields indicate?

Brazil’s 10-year sovereign debt is currently trading at yields below 11%. Last the markets saw yields in this Latin American (ILF) continent drop below the 11% mark was in mid-2013. Since then, benchmark bond yield in Brazil has been rising amid deteriorating economic conditions, thereby, increased riskiness in this emerging market (EEM) (VWO) economy. A higher yield often entails a higher risk profile and vice versa.

Brazil: Then

Over the last 3 years, Brazil (EWZ) (BRZU) (BZQ) has witnessed economic recession, rising unemployment, and rampant inflation, not to mention, a heightened corruption involving state-owned oil company, Petrobras (PBR) (PZE). For an economy where commodity exports account for a major portion of its export revenues, the decline in commodity prices since mid-2014 only added fuel to the countries economies woes. Iron ore, oil, and sugar comprise the top 3 exports of Brazil accounting for about 12%, 9% and 4.3% of its export revenue, respectively.

August 2016 saw the impeachment of Dilma Rousseff from her post as President, being found guilty of fiscal pedaling. Since then, Brazil is being run under the leadership of its new President Michel Temer, who took office August 31, 2016.

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Brazil: Now

But the storm seems to have turned from Brazil now. Inflation has slid from a 10.71% recorded in January this year to 6.29% currently. The Brazilian real, which had largely been depreciating since 2013, finally turned course. Since January 2016, however, the currency has already appreciated by about 22.7% (from BRL 4.1 per US dollar in January 2016 to BRL 3.17/USD currently). However, unemployment continues to rein the double-digit regime at 11.9%.

Nonetheless, the Brazilian stocks markets; a leading indicator of economic expectations; are up by almost 40% over the last 2 years.

The yield on the government’s 10-year bond has also been sliding over the period; from 16.76% in January last year, it recently dipped below 11% in January 2017. This is the first time since mid-2013 that we’re seeing yields on Brazil’s 10-year sovereign debt dip below the 11% mark.

Is the worst over for Brazil?

According to an OECD (Organization for Economic Co-operation and Development) forecast, “The economy is emerging from a severe and protracted recession. Political uncertainty has diminished, consumer and business confidence are rising and investment has strengthened. However, unemployment is projected to continue rising until 2017 and decline only gradually thereafter. Inflation will gradually return into the target range.”

According to the IMF, Brazil’s economic prospects hinge on the new government’s ability to implement ambitious structural reforms to restore fiscal sustainability. Risks continue to dominate the outlook, but positive signs are emerging.

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