Brazil Real Volatility at Six-Month High After S&P Downgrades

El-Erian: Brazil Is Stuck in a Vicious Cycle
  • Rating Cut seen as wake-up call for nation's politicians
  • Currency is poised to end the tumultous week with a loss

Brazil’s real volatility climbed to a six-month high as traders weighed whether Standard & Poor’s move to cut the nation’s credit rating to junk will prompt lawmakers to work with the government to shore up the budget.

One-week implied volatility on options for the real, reflecting projected shifts in the exchange rate, increased to 26.45 percent Friday, the highest among 16 major tenders tracked by Bloomberg. The currency dropped 0.6 percent to 3.8708 per dollar, the lowest in almost 13 years as commodities fell. It’s down 0.7 percent this week.

Stung by record-low popularity and a graft scandal at the state-controlled oil company, President Dilma Rousseff is struggling to win lawmakers’ support for measures that would curb debt, tackle inflation and avoid more downgrades. S&P assigned a negative outlook to its rating when it cut the country to junk, meaning more cuts could be on the way. The New York-based company said the political stalemate and repeated reductions in the government’s budget target have undermined the country’s creditworthiness. 

"Brazil’s downgrade should force a fiscal cleanse," Joao Paulo de Gracia Correa, a foreign-exchange manager at SLW Corretora de Valores, said from Curitiba, Brazil. "Now is the time for Congress to act with the government to sort out the mess, and this cut might expedite things."

Brazil’s government is in a hurry to promote changes after being cut to junk, and members of the largest party in Rousseff’s coalition want a reduction in spending before negotiating any tax increases, O Estado de S. Paulo reported, without saying where it got the information. Rousseff called an emergency meeting Thursday to ask for government officials to work together and announce fiscal measures faster, the newspaper reported.

Fitch rates Brazil two steps above junk. Moody’s ranks Brazil at Baa3, its lowest investment grade. S&P’s new score puts Brazil on par with Hungary, Russia, Bulgaria and Indonesia.

"While there is now hope that the downgrade was a wake up call for the government as pressure on Rousseff is increasing, it is too early to call that the government is now planing long-awaited structural reforms that would boost growth in Brazil," Societe Generale SA strategist Bernd Berg said from London. "As long as we do not see any bigger concrete steps, international investors will remain skeptical and the real under pressure."

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

Swap rates on the contract maturing in January 2017, a gauge of expectations on interest-rate moves, declined 0.13 percentage point to 15.15 percent. Rates are up 0.11 percentage point for the week.

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