Brazil's Real Leads World Declines as Bonds Tumble After S&P Cut

Brazil Returns to Junk Status, Bonds Tumble
  • Shares of Petrobras, Itau among hardest hit in Ibovespa
  • Currency retreats to lowest level since October 2002

Brazilian markets tumbled after Latin America’s largest economy returned to junk status as it struggles to overcome a crippling recession.

 
The real fell 1.8 percent to 3.8496 per dollar, the most among major currencies, after the nation lost its investment-grade rating at Standard & Poor’s. The Ibovespa stock index dropped 0.3 percent to 46,503.99, trimming an earlier slump of 2.3 percent. Oil producer Petroleo Brasileiro SA, which was also downgraded to junk, extended this year’s plunge. Yields on Brazil’s $4.3 billion of bonds due in 2025 rose to the highest since they were issued in 2013. The iShares MSCI Brazil Capped ETF exchange-traded fund touched a decade low.

Societe Generale SA, BNP Paribas SA and Nomura Holdings Inc. all predicted the real would sink past 4 per dollar in coming weeks. The downgrade to BB+, the highest speculative grade, highlights the failure of President Dilma Rousseff’s administration to shore up the government’s budget amid forecasts for the longest recession since the 1930s, inflation at a 12-year high and a collapse in prices for Brazil’s commodity exports. S&P’s negative outlook means it may reduce the grade further, even as Fitch Ratings and Moody’s Investors Service keep the country at investment grade for now.

Brazil Woes

"It’s one blow after another for Brazil,” said Nicholas Spiro, managing director of Spiro Sovereign Strategy, an advisory firm in London. “While Brazil has been trading as a junk credit for some time now, the loss of its investment-grade status throws the severity of the country’s economic and political woes into sharp relief.”

Fitch, which has Brazil two steps above junk, pointed to risks to its rating at a conference in London this week. Moody’s ranks Brazil at Baa3, its lowest investment grade. Both companies declined to comment on S&P’s action, which
put the nation on par with Hungary, Russia, Bulgaria and Indonesia.

Brazil’s bond risk as measured by credit default swaps rose to the highest since 2009. The extra yield investors demand to hold the country’s debt instead of Treasuries rose 0.12 percentage point to 3.97 percentage points, according to data from JPMorgan Chase & Co. Petrobras’s $2.5 billion in bonds due 2024 and Banco do Brasil SA’s $2.5 billion in perpetual bonds tumbled to the lowest on record. Swap rates surged to the highest since December 2008.

The Treasury canceled an auction of fixed-rate bonds, citing
market conditions. It gave the same reason when it scrapped the sale of the securities Sept. 3. While the government doesn’t disclose the size of the auctions before they are held, the most recent offering of fixed-rate notes on Aug. 27 raised 9.7 billion reais ($2.5 billion).

Brazil’s stock market lost almost $600 billion in value over the past year. The selloff deepened the valuation discount of the MSCI Brazil Index relative to emerging markets, according to data compiled by Bloomberg based on estimated earnings. Yet the slide hasn’t created a buying opportunity, according to Schroder Investment Management and UBS AG.

We won’t turn bullish on Brazil until the political situation is resolved either by President Rousseff “adopting a different policy stance or being replaced by someone that can restore confidence,” Allan Conway, the head of emerging-market equities at Schroder, said from London.

Petrobras, Itau

Among the hardest hit stocks Thursday was Petrobras, which led losses in the Ibovespa. Itau Unibanco Holding SA, Latin America’s largest bank by market value, extended this year’s slide to 16 percent. Iron-ore producer Vale and planemaker Embraer SA rallied with Brazilian exporters amid wagers they’ll benefit from the drop in the currency.

The real has tumbled 31 percent in 2015, while the Ibovespa has lost 36 percent in dollar terms, the most among the world’s biggest markets.

“The first reaction will be to sell, but there’s hope that this is the shock the politicians need to take action," said Paul McNamara, who manages $4.5 billion in assets as investment director at GAM in London.

Levy Speculation

The downgrade rekindled speculation that Finance Minister Joaquim Levy may resign his post in frustration at the difficulty of winning support for fiscal measures, as well as consideration of whether it could serve as a wake-up call and reinforce his message that legislators need to act faster.

Brazil will take legislative action to boost efficiency and productivity to spur growth, Levy said in an e-mailed statement following the downgrade. Macroeconomic measures this year are already reflected in the rebalancing of external accounts and lower inflation expectations for 2016 and 2017, he added.

“Standard & Poor’s actually did Joaquim Levy a favor to help him convince the Brazilian government that a radical change is necessary,” said Adeodato Volpi Netto, the head of capital markets at research firm Eleven Financial in Sao Paulo. “Switching the economic policy is the only alternative we have
now.”

Record Low

Rousseff’s popularity, meanwhile, is at an all-time low amid an investigation into corruption that allegedly occurred while she was chairman of the state-run oil company. This has helped spur calls for her impeachment and sparked a wave of nationwide protests.

S&P’s step also raised the specter of downgrades for the so-called BRICS group of the five major emerging-market economies, which includes Brazil, Russia, India, China and South Africa.

That’s “probably the biggest risk for emerging markets as a whole,” Simon Quijano-Evans, the chief emerging-market strategist at Commerzbank AG in London, said in an e-mailed note.

The MSCI Emerging Markets Index dropped 0.7 percent, halting a two-day gain.

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