NEW YORK (IFR) - A report that Brazil’s President Michel Temer had approved a hush-money payoff left the country’s bond markets in disarray on Thursday as investors reassessed their views of the sovereign.
Spreads on Brazil’s five-year credit default swaps were off their intra-day wides by early afternoon, but were still about 60bp weaker at 268bp, according to Thomson Reuters data.
Cash bonds remained under pressure, however, with Brazil’s 2026s quoted at around 106.00-106.50, or close to four points lower on the day.
A report that Temer was caught on tape discussing a payment to jailed former house speaker Eduardo Cunha to prevent him from testifying unsettled a buyside that had been betting on an improving credit scenario for Brazil.
“It took a lot of people by surprise,” said Ricardo Navarro, a portfolio manager at asset management firm Noctua. “Political risks were not necessarily priced in.”
This follows a substantial rally in Brazilian asset over the last few months on hopes that the economy was finally on the mend following a bribery investigation that has ensnared swathes of the country’s political and business classes.
It was only last week that spreads on sovereign’s five-year credit default swaps broke through the 200bp mark for the first time since January 2015, according to Thomson Reuters data.
But with Temer now at the center of Brazil’s far-reaching corruption scandal, many prior assumptions are in doubt.
“A lot of people came late to the trade with low conviction, and you may see a lot those flows go away,” Navarro said.
The government’s reform agenda on which markets had placed such high hopes could well be sidelined, raising doubts about the country’s ability to get its fiscal house in order.
“The most immediate risk is that the pension and social security reform is dead in its tracks,” said Sean Newman, a senior portfolio manager at Invesco.
If Temer resigns - something he has so far has resisted - reforms could still go through.
“There is still support in Congress, so if Temer resigns and we get an election, we still have a path for reform,” said Jim Barrineau, co-head of emerging market debt at Schroders.
“But if he doesn’t reign and decides to fight this for an extended period, that is a much messier situation.”
The latest news will also likely put the brakes on new issuance out of the country, with state-owned oil company Petrobras having only just tapped its curve on Monday for US$4bn.
Some investors are already making a case for the Petrobras tap to be recalled following Thursday’s steep sell-off.
“Primary Brazil will be quite dead for a while,” said a banker.
Spillover into other LatAm countries - particularly Argentina, which has strong trade links with its neighbor to the north - was also being felt.
A peso bond scheduled this week from the Province of Buenos Aires failed to emerge on Thursday after the borrower completed roadshows on Wednesday.
But any fallout is expected to be contained.
“Back when the Brazil saga broke two years ago, there was limited contagion, and we think the same situation will play out now,” said Invesco’s Newman.
Reporting by Paul Kilby; Editing by Marc Carnegie