Brazil ETF Fights Off Troubling Economic News

Once one of the most savagely repudiated single-country emerging markets exchange traded funds, the iShares MSCI Brazil Capped ETF (NYSE:EWZ) is regaining its darling status this year. EWZ, the largest Brazil ETF, is up more than 41 percent year-to-date, or more than five times the returns offered by the MSCI Emerging Markets Index.

Over the past month, EWZ is higher by 9.5 percent, a performance that can be either as impressive or indicative that financial markets have priced in the fact that Latin America's largest economy is mired in a recession and economic data there is not improving.

Brazils GDP shrank 1.4% on a quarterly basis in Q4 2015, dropping at a record rate of 3.8% in the year as whole. Worryingly, PMI data suggest that the economy is yet to hit rock bottom. The Markit Composite PMI Output Index, which combines data from the manufacturing and dominant service sectors, averaged 41.7 in the first quarter of 2016, down from 43.7 in the preceding period. Severe downturns in activity have been recorded in manufacturing and services, with the latter seeing the sharpest drop in output in the history of the series during February, said Markit in a recent note.

While Brazil's economic woes are steep, investors have been focusing more on politics this year, meaning President Dilma Rousseff and her fragile grasp on power. Speculation that Rousseff will eventually be impeached has been one of the primary drivers of EWZ's 2016 bullishness.

Among those problems are high inflation that makes it difficult for Brazil's central bank to lower interest rates, which, at 14.25 percent, are among the highest in the world. The central bank there is hoping for inflation of 6.5 percent, but recent data indicate inflation in Brazil is nearly 300 basis points higher than that.

As widely expected by financial markets, Brazils central bank kept its benchmark SELIC rate unchanged at 14.25% following its April meeting its highest mark in almost ten years. Interest rate policy is being steered by the need to curb inflation without damaging an already-troubled economy. Consumer prices rose 0.43% in March, below Februarys reading of 0.90%, but contributing to a 12-month cumulative reading of 9.39% which is well above the central banks upper limit of 6.5%. GDP is forecast to shrink at a sharper rate in 2016, after plummeting 3.8% in 2015, adds Markit.