Not Even World's Highest Rates Keep Foreigners in Brazil Bonds

  • Overseas holdings have fallen to the lowest since December
  • Dropoff shows foreign investors' bearish outlook on Brazil

The outlook for Brazil is so bad that even the highest interest rate among major economies can’t keep foreign investors in the market for government bonds.

Percentage of total outstanding sovereign domestic bonds
Percentage of total outstanding sovereign domestic bonds

Non-resident holdings of local notes have dropped to the lowest level this year amid growing speculation that President Dilma Rousseff won’t be able to fulfill promises to reduce government spending and shore up finances. Her pledge Monday to shut down 10 ministries and sell properties to raise cash failed to reverse a selloff in risky assets that sent yields on the country’s 10-year debt to a record 14.18 percent.

Foreigners are souring on Brazil as analysts forecast the longest recession since the 1930s amid a sweeping graft scandal at the state-run oil company and a political crisis that has included calls for Rousseff’s impeachment. Inflation is still running above target after policy makers raised interest rates seven times since October, and concern the country’s credit rating may be cut to junk has sent the real tumbling.

“Brazil is a big combination of bad news at the moment,” said Joao Medeiros, a director at currency brokerage Pioneer Corretora de Cambio in Sao Paulo.“Even though returns in fixed-income assets can be robust, volatility is high and the drop in the currency spreads concerns among investors.”

The total share of Brazilian local public debt held by foreigners has decreased to the lowest level since December, according to data released by the Treasury on Monday. Foreign holdings were down to 484 billion reais ($136 billion) in July, from 494 billion reais in June.

On Monday, Brazil’s fixed-rate government notes due in 2025 fell for the eighth straight day. Yields on the bonds have increased almost 2 percentage points this year and are now the highest among similar debt from 16 developing nations after Nigeria, according to data compiled by JPMorgan Chase & Co.

As bond yields soared, the real has plummeted this year, exacerbating losses for overseas investors. The currency has plunged 25 percent in 2015, the worst performance among 16 major currencies tracked by Bloomberg. It declined 1 percent to 3.5886 per U.S. dollar as of 3:15 p.m. in New York.

Foreigners’ holdings are volatile and closely related to global events, as well as what happens in Brazil, according to Jose Franco, the general coordinator for public debt operations at Brazil’s Treasury.

“The same way it dropped in July it could rise in August,” he told reporters in Brasilia on Monday. The fact that 80 percent of the local debt is held by domestic investors means the country is less exposed to the risk of capital flight, Franco said.

Moody’s Investors Service and Standard & Poor’s already rate Brazil at the lowest level of investment grade, while Fitch Ratings is one step higher at BBB. When Moody’s cut its rating Aug. 11, it cited faltering growth and a lack of political support for Rousseff to shore up the budget.

As foreigners flee Brazil’s local bonds, bets against Brazil’s tender by overseas investors in Sao Paulo’s futures stock exchange declined to the lowest level since January on Aug. 21, data compiled by Bloomberg show. That could be an indication that foreign investors are hedging less because they own fewer bonds, according to Medeiros.

Borrowing dollars at the end of last year and selling them to buy reais in a so-called carry trade lost 19 percent, the worst performance among major currencies tracked by Bloomberg.

Foreign exchange option contracts held by offshore investors in over-the-counter transactions tracked by Bloomberg show traders are pricing in a scenario in which the currency can depreciate to 3.9 per dollar by year-end.

In a note to clients Aug. 12, Goldman Sachs Group Inc.’s Kamakshya Trivedi and Alberto Ramos said the real will decline to 4 per dollar by year-end. That compares with a previous forecast of 3.55. Societe Generale strategist Bernd Berg also estimates the currency will drop to 4 per dollar by October.

The retreat by foreign investors comes at a tough time for Brazil as the government tries to stem a widening current account deficit, according to Mark McCormick, an emerging-markets strategist at Credit Agricole SA in New York.

“In the short-term the real is oversold, but in terms of valuation it is still rich based on standard econometric models,” McCormick said in an interview.

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