Photographer: Patricia Monteiro/Bloomberg

Thank You, Mexico -- Brazilian Bonds Can Take It From Here

Updated on
  • Sovereign spreads are at same level as Brazil’s risk improves
  • Nafta talks, election uncertainty have weighed on Mexico

For the first time in four years, Brazil can pay about the same as Mexico to borrow, underscoring a remarkable comeback by Latin America’s biggest economy from a nadir of recession and corruption.

Brazil government bonds now trade at 247 basis points more than U.S. Treasuries, down 83 basis points this year, according to JPMorgan indexes. That’s in line with Mexico’s 251-basis-point premium and reflects investor optimism that Brazil will take further steps to get its fiscal accounts in order. Mexico, meantime, has been weighed down by Nafta tension and a potential populist shift in its leadership.

"Investors have given Brazil credit for its growth recovery and reform progress," said Lucy Qiu, a New-York based emerging-markets strategist at UBS AG, which is overweight on Brazilian dollar bonds and neutral on Mexico. "For Mexico, recent harsh rhetoric out of the Nafta negotiation, and a potential Andres Manuel Lopez Obrador win in next year’s presidential election, have dampened investor sentiment lately."

Brazil and Mexico’s sovereign bond spreads moved together in the years following the financial crisis. They began to diverge in mid-2013 as Brazil’s borrowing costs climbed amid fiscal deterioration and political turmoil that spooled into the impeachment of former President Dilma Rousseff in 2016.

Brazil’s borrowing costs fell and approached Mexico in the beginning of the year as the government approved a spending cap to help trim the budget deficit, before spiking in May when President Michel Temer was engulfed in a new corruption investigation. The risk premium fell again after he managed to shelve the charges.

Mexican bond spreads matched a compression in emerging-market assets this year, but the move was limited by mounting concern the North American Free Trade Agreement may not survive, dealing a blow to Mexican exports to the U.S., as negotiators decided to extend talks into 2018. 

That added to existing concern about Mexico’s political outlook as Obrador rose in polls for next July’s election. He has signaled opposition to constitutional changes approved under President Enrique Pena Nieto, in particular the end of state-owned Petroleos Mexicanos’ monopoly on oil production.

Granted, there’s no guarantee Brazil’s out of the woods yet. Its much-heralded revamp of the nation’s costly and inefficient pension system may yet falter, skewering much of the effort to trim public debt. For Mexico, the Nafta talks may well succeed, and Obrador could fade in the polls. Brazil’s real fell 0.4 percent to 3.26 per dollar as of 11:01 a.m. in New York.

Still, the cost of insurance against Brazil’s default -- as measured by credit default swaps -- declined twice as much as Mexico’s this year and improved even in recent weeks, when the country’s currency and stocks fell on concern about the slow pace to approval of the pension bill.

Investor optimism allowed Brazil to sell dollar bonds last month at a lower yield than initially targeted. The benign backdrop for emerging markets is also allowing new bonds to be issued at lower costs than initially planned, said Michael Arno, an analyst at Brandywine Global Investment Management, which has $74 billion under management.

"Continued quantitative easing from the major central banks has kept a lid on yields," he said. "And bonds still trade OK once the deal closes."

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