Brazil’s World-Beating Bonds Still at Mercy of Corruption Probe

(Bloomberg) -- Brazil has just roared back in the bond market. But to some market watchers, the nation still remains far too vulnerable to its unpredictable politics.

Real-denominated notes have topped emerging markets this year with returns of 46 percent in dollars. Debt from companies like mining giant Vale SA have led the rally as investors gained confidence the newly formed government can pull the economy out of its longest recession in more than a century.

Yet despite all the optimism, Acting President Michel Temer still confronts many challenges. One of the biggest is the risk his administration will become ensnared in the long-running bribery investigation of Petrobras, the state oil company. Since he took office in May to replace President Dilma Rousseff, who faces an impeachment trial, Temer has already seen three of his appointed ministers step down because of the investigation.

“Politics remain as the wild card when it comes to looking at Brazil today,” said Bianca Taylor, a sovereign analyst and strategist at Loomis Sayles & Co., which oversees $229 billion. “Everyone knows it is the main risk, and it is hard to tell how far things can go.”

Temer, 75, also has the tough task of shoring up Brazil's finances. He has pledged to lower pension payments as part of his push to cut spending and reduce a near-record budget shortfall.

A vote to permanently oust Rousseff also looms. On June 21, Temer said a final impeachment vote is expected to occur by mid-August.

Still, with more than $9 trillion of the world's government debt yielding less than zero, Brazil continues to lure investors, according to Juan Carlos Rodado, the director of Latin America research at Natixis North America. Brazil's benchmark interest rate, known as Selic, is the highest among major economies at 14.25 percent.

“The change of management is an improvement,” Carlos Rodado said from New York. “In the current hunt for yield, investors are happy with the change.”

Local-currency bonds are also getting a boost from the real's 24 percent surge this year, which has inflated returns for so-called carry-trade investors. The real dropped 0.7 percent to 3.2373 per dollar as of 4:25 p.m. in New York.

“In a way, Brazil is an idiosyncratic story with no correlation with Brexit considerations,” said Societe Generale strategist Regis Chatellier, referring to the market volatility unleashed by the U.K.'s vote to leave the European Union last week. Still, “political headwinds are the main issue.”

To contact the reporter on this story: Filipe Pacheco in Sao Paulo at fpacheco4@bloomberg.net. To contact the editors responsible for this story: Brendan Walsh at bwalsh8@bloomberg.net, Michael Tsang at mtsang1@bloomberg.net, Lester Pimentel, Rita Nazareth