Not Yet An EM Fixed Income Safe Haven

We continue to highlight our concerns over persisting fiscal slippage and the increasing role of politics in the economy in the run-up to October's elections. However, perhaps the most significant risk for Brazil's impressive sovereign rating credentials is the economy's high reliance on Chinese demand. We reiterate that of the top commodities exported in 2009, such as crude oil, iron and soy, 70% were destined for China alone. Our Asia team has frequently been highlighting the possibility of China's asset bubble bursting in the near term, which was reflected in our short Se Shang Property Index position, on which we saw implied gains of 11.9% between early April and May. While Brazil's benchmark global bonds have recently been outperforming relative to their Russian BRIC peers, we caution that a sharp downturn in Chinese demand over the course of H210 and 2011 could significantly undermine Brazil's near-term sovereign credit profile.

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