Brazilian markets hammered as political crisis reignited

Brazilian assets were hit hard on Thursday as markets woke up to the possibility of yet another disruptive change of president just as the country was showing signs of emerging from two years of deep depression.

The real fell 7 per cent to 3.37 against the US dollar as Brazil’s markets opened, wiping out all of this year’s gains and taking the currency back to its level of last December. The real had been trading below 3.10 to the dollar as recently as Wednesday. Brazilian stocks plunged just over 10 per cent at the open, with the drop in the benchmark Bovespa triggering a circuit breaker that halted trading.

Investors have piled into Brazil’s currency, stocks and bonds this year, believing that the government of President Michel Temer — installed last August after the impeachment of his predecessor Dilma Rousseff — would enact reforms to balance the public accounts and lead the economy back to growth after a combined contraction of 7.4 per cent in 2015 and 2016, according to the central bank.

But many feared such hopes had been dashed after national television reported on Wednesday night that Mr Temer had been recorded encouraging the bribery of a key figure in the lava jato corruption scandal that has engulfed large sections of Brazil’s business and political leadership. The president’s office denied he had done anything improper but investors appeared to have dumped assets en masse fearing that the episode could derail his reform programme.

“We’re all in buckle-up, wait-and-see mode,” said Kevin Daly, portfolio manager for emerging markets debt at Aberdeen Asset Management. He expected to see “knee-jerk selling, with pretty much everything going limit down at the open”, although he did not expect forced selling “per se” of other EM assets.

The American Depository Receipts of Petrobras, the government-controlled oil group at the centre of the corruption scandal, shed more than 12.5 per cent of their value in after-hours trading in New York on Wednesday night.

Analysts at Morgan Stanley noted that fixed income investors had overweight positions in Brazil that were among the largest in the asset class along with Mexico and Russia — the former bouncing back from fears of protectionism in the US, the latter, like Brazil, coming out of deep recession.

They noted on Thursday morning that Mr Temer’s alleged involved in cover-up and bribery “would, if confirmed, raise serious questions about the administration’s ability to govern”.

They added: “With much of the asset price recovery in Brazil based on the growth-enhancing effects of fiscal reform, a sizeable market reaction could ensue.”

It was collapsing support among the population and, crucially, in Brazil’s Congress that ultimately cost Ms Rousseff her job. Mr Temer’s approval rating has sunk to just 9 per cent, with many voters alarmed that his reforms will remove generous pensions entitlements.