Populism of the next government could take the dollar to R$8 and the Selic to 20%, says manager

Depending on the policies in the economic field to be adopted by the government that emerges victorious in this year’s elections, foreign investors can promote a strong capital rescue, with significant impacts on inflation, interest rates and the dollar.

The assessment is by Ales Koutny, a Brazilian manager focused on emerging markets at British investment firm Janus Henderson, with about US$ 360 billion (R$ 1.95 trillion) in assets.

With a very different view of market pairs, Koutny says he does not rule out a scenario in which populist policies cause a sharp outflow of resources from Brazil, which could lead the dollar to test levels around R$ 7.50 or even BRL 8.00. He also sees the possibility of the Central Bank continuing with the monetary tightening process to levels of up to 20% per year.

In the Focus bulletin, which captures the projections made by economists consulted by the BC, the estimate is that the American currency will remain at R$ 5.20 for both the end of 2022 and 2023, while the Selic rate should be 13, 75% and 10.75%, respectively.

“We may start to see a situation where inflation skyrockets and the currency depreciates. In these scenarios, the only way to regain credibility is to keep raising interest rates,” the London-based manager said in a video interview. The Sheet.

Due to uncertainties about the country’s policy from 2023, Koutny claims to have recently withdrawn the real from the portfolios of the manager’s funds dedicated to emerging markets, replacing it with the Mexican peso.

He also says that, given the lack of visibility on the horizon of the local market at the moment, he does not consider that the Brazilian stock exchange is cheap. “Brazil has been a great region for investors, but our assessment is that most of the gains are gone.”

What is the perception of foreign investors in relation to the Brazilian market at the moment? Because of the War in Ukraine, and events that are taking place in other emerging countries, such as Chile, Egypt and Asia, with high inflation and the protests that are affecting these regions, many people decided to come to Brazil in terms of foreign investors, not least because, due to commodities rising very strongly, it was a place where they would have a safer port.

The problem is that this story happened in the first half of this year, and now, when we look at the second half of the year, the situation is more difficult. Foreign investors still have a large allocation in Brazil, at the same time that inflation continues to surprise upwards and the local currency has started to devalue, in part due to the commodities that the country exports, which have seen prices stabilize or even fall pretty hard.

And we still have political events on the calendar that will start to get on investors’ radar, and that can be a big problem, because the main question is not who wins, but what the policies of whoever wins will be.

We are seeing a leftist wave in Latin America, it started in Mexico four years ago, then Chile and now more recently Colombia. And in Brazil, as much as there is a fight between left and right, the policies of the right are becoming more leftist.

The problem is that these policies often tend to point the finger at investors and the market, or semi-government companies, to raise money to be able to pay for these policies. And this creates a whole uncertainty in relation to what we call “market friendly” [relação amigável com o mercado]. In Colombia, we saw an example like this, when the victory of the candidate more focused on local subsidies, on helping the low-income population and on climate change, promoted policies in this sense at the cost of Ecopetrol, which is basically the Colombian Petrobras.

Has Janus Henderson made recent moves in relation to the Brazilian market due to the uncertainties in the scenario? In mid-July, we cut our exposure to the real, and basically switched our exposure from Brazil to Mexico, because we still like the topic of emerging markets that have a strong export agenda. As much as the situation in Mexico has its ups and downs, the situation in the country is already better known, while in Brazil we still have two, three months for the elections, in order to better understand what policies will be adopted next year, the which is something that affects the perception of the Brazilian market abroad.

What is your assessment of Mr. about the attractiveness of the Brazilian stock exchange at the current price level? We perceive a local rhetoric, according to which many people think that the Brazilian stock market is cheap. But, if we analyze the stock exchange in terms of commodities and in relation to other international markets, our assessment is that it is not cheap.

If everything really goes in Brazil’s favor and great things happen, the Brazilian Stock Exchange is at a decent price. But if some of the things I’ve mentioned continue to make the country’s situation worse, it certainly doesn’t come cheap. And even if everything goes well for Brazil, but the markets abroad continue to fall sharply, the chances of the stock market rising from the current level are minuscule.

Brazil has been a great region for investors, but our assessment is that most of the gains are already gone, and even though some opportunities begin to appear, care is essential, because it is necessary to take into account the series of risk factors that are going to be a problem in the second half of the year.

like mr. has it followed the fiscal dynamics in the Brazilian market, with government initiatives to increase public spending? Not very well. The main question we assess is how sustainable a country’s debt is. In the case of Brazil, if populist policies continue to advance in the direction of increased spending, and commodities continue to fall, these are trends that will greatly affect the government’s fiscal ceiling, which means that we will have the same type of conversation again. that we had at the time of the Social Security reform.

With the increase in fiscal risk in Brazil, should the BC have to promote even more increases in the Selic rate above market forecasts? This is one of our big bets. The local market seems to have some confidence in the BC and continues to price just another 0.50 percentage point increase in the Selic rate, but we strongly disagree with that.

First, because it will be the third or fourth time that the BC says that we are now approaching the end of the cycle of high interest rates. So if it continues to rise another 0.25 point or 0.50 percentage point, it won’t be exceptional. But the most important is the question of the political scenario in Brazil. Assuming that no policy is too extreme, theoretically inflation in Brazil is on a deceleration trajectory towards the end of this year, beginning of next year.

The problem is, if policies start to come in a way that the market interprets in a very negative way, and foreigners decide to leave the country, we will see very high pressure on the currency.

If the market loses faith in the government’s policy, as we see in Argentina, even if the government decides to fix the exchange rate or adopts other measures to contain inflation, we can start to see a situation where inflation soars and the currency depreciates. . In these scenarios, the only way to regain credibility is to keep raising interest rates.

We estimate at about a third the probability that the interest rate in Brazil will reach 18%, or even 20%, it is something that will depend on the political issue in the country, and if, under a new government, it is a renewal of the current government. or a new government, how populist the measures they want to take are going to be, and how they are going to finance it.

In this scenario, how far could the real depreciate? In a scenario like this, I wouldn’t be surprised to see the real against the dollar at R$7.50, or even R$8.00. By our models, and by the models of the IMF and the World Bank, they basically show that the value of the real is cheap in relation to its fair value. The thing is, when political issues come into the mix, the fair value of a currency matters least.

In the long term, we can see a return and stabilization of the currency to stronger values, but we assess that, in a negative situation, in which populist policies continue to be adopted, and without new privatizations or new attitudes to finance these policies, we assess that the Foreign sentiment towards Brazil will get much worse, and this generates all this panic, and once this panic enters the market, it is very difficult to contain it.

What is your assessment of the proposals in the economic field of the two main candidates in the electoral dispute in Brazil? The two camps are quite different in terms of how they want to achieve economic growth. One favors more the distribution of income to the population, with a greater focus on the consumer sector, while the other is, theoretically, more favorable to business and entrepreneurship.

The thing is, we usually prefer to see actions over speeches. Because it’s common to see a lot of promises and a lot of feedback, both positive and negative, but when it comes time for implementation, the end result is significantly different from what was expected. We can see this in various periods in the history of Brazilian politics. Due to the country’s political system, which depends a lot on Congress, with many different parties, and because of all the necessary coalitions, we ended up seeing many changes in relation to the original promise.

X-ray | Ales Koutny by Janus Henderson

Ales Koutny is a portfolio manager for emerging markets at Janus Henderson Investors, a position he has held since 2022. Prior to joining the British manager as a portfolio analyst in 2015, he was an analyst at JP Morgan Asset Management. Ales holds a master’s degree in finance with a specialization in behavioral economics from the Grenoble Graduate School of Business.