Bus-Fare Furor Shows All That’s Wrong in Brazil for Bonds

The nine-cent increase in bus fares in Sao Paulo is coming to symbolize everything that’s wrong with Latin America’s largest economy -- for protesters and bondholders alike.

About 50,000 people massed throughout Latin America’s largest city last night as a rally against a 20-centavo rise in fares two weeks ago erupted into nationwide demonstrations against everything from rising prices to corruption and excessive spending. The unrest has deepened a rout in Brazil’s local bonds, which fell 7.4 percent in dollars in the past month as the real sank and the central bank raised interest rates.

After a decade that saw the nation win its first investment grade and lift 40 million people out of poverty, Brazilians are now protesting policies of President Dilma Rousseff and Finance Minister Guido Mantega that have fueled inflation and boosted debt while failing to spur an economy hobbled by its slowest stretch of growth in a decade. Brazil’s creditworthiness based on swaps is eroding at the fastest pace among major emerging markets as Standard & Poor’s this month cut its rating outlook, citing a sluggish economy and a loss of investor credibility.

“The combination of social protests with a crisis of market confidence is a potent mix,” Christopher Garman, Latin America director at New York-based consulting firm Eurasia Group, said by telephone from Washington. “The only earnest card she has is changing her economic team.”

Declining Bonds

The 7.4 percent decrease on local bonds in dollars in the past month exceeds the 4.5 percent drop in emerging-market local debt, according to Bank of America Corp. Yields on Brazil’s 10-year local bonds have risen 1.28 percentage points in the past month to 11.16 percent, a one-year high.

The Finance Ministry declined to comment on the protests and the prospect of a cabinet shakeup including replacing Mantega.

Bus fares, which are adjusted annually, went up 7 percent to 3.2 reais ($1.50) on June 1 in Sao Paulo, Rio de Janeiro and other cities, sparking a frenzy of online activism that eventually poured into the streets. Sao Paulo Mayor Fernando Haddad said yesterday that he is open to reducing the cost of transport.

An estimated 215,000 people marched in 11 cities across Brazil on June 17 in one of the biggest demonstrations since the nation’s dictatorship ended in 1985. Protesters halted traffic in Sao Paulo, attacked the state legislature in Rio de Janeiro and climbed onto the roof of Congress in Brasilia.

Brazil’s Future

What the protesters and the market have in common is that they both see a deterioration in the future of Brazil, according to Andre Perfeito, the chief economist at Gradual Investimentos in Sao Paulo.

“The financial markets are selling at any price because they don’t see value anymore,” Perfeito said by phone. “The protesters want to reconstruct the future of the country.”

Annual inflation accelerated to 6.5 percent in May, matching the upper limit of the central bank’s target range. It has remained above the 4.5 percent midpoint since central bank president Alexandre Tombini took office in January 2011.

Above-target inflation prompted policy makers to boost interest rates by 0.75 percentage point this year to 8 percent after lowering them by 5.25 percentage points in cuts that began in August 2011. Policy makers will raise the target lending rate to 9 percent this year, according to the most recent central bank survey of about 100 analysts.

Weakening Real

The real has plunged 6.5 percent in the past month, the most among major currencies, and touched 2.1856 per dollar yesterday, a four-year low.

Brazil is rated BBB by S&P, two steps above junk, and an equivalent Baa2 by Moody’s Investors Service and BBB by Fitch Ratings.

The tumbling currency and prospect of rate increases have prompted investors to shun Brazil’s local fixed-rate bonds. The Treasury bought back fixed-rate bonds due in 2021 and 2023 in an unplanned auction yesterday, the second time it has done so in the past week. The auctions were the first unplanned buybacks since 2008, according to the Treasury.

Scrapped Tax

Brazil’s decision to scrap a tax on foreigners’ local bond purchases on June 4 has failed to reverse the plunge. The selloff in the currency and bonds are also coming at a time when investors globally are avoiding higher-yielding assets on concern the Federal Reserve may scale back its asset purchases.

“External factors were more influential this month, but throughout 2013 domestic factors have weighed heavily” on the bonds’ performance, Ronaldo Patah, who helps oversee 150 billion reais of fixed-income assets at Itau Asset Management, said in a telephone interview. “Inflation, worsening of the fiscal accounts, the current account deficit -- three factors caused demand for fixed-rate bonds to fall a lot.”

To meet last year’s budget targets, the government boosted its dividends from state-run companies and resorted to several accounting maneuvers criticized by investors.

Mantega, in a June 12 interview with Bloomberg, declined to discuss his future except to say that he plans “to work intensely so that the Brazilian economy by the end of 2014 is growing at a beautiful rate, with robust investment and maintaining full employment.”

Mantega Prospects

Rousseff is unlikely to replace Mantega in the near term, but a further deterioration of investor confidence could force her to do so in the future, Garman said.

Marco Freire, who oversees 3 billion reais as chief investment officer for fixed income at Franklin Templeton Investimentos in Sao Paulo, says that the selloff in Brazilian assets is primarily due to concern the Fed may curb stimulus.

“The majority of this movement is global,” Freire said by phone from Sao Paulo. “It began abroad with the idea that the Federal Reserve would buy less bonds, and that triggered the move in rates and a weakening of currencies that hit Australia, Turkey, Poland, Mexico and Brazil.”

The cost to protect Brazil’s dollar bonds against losses has jumped 0.38 percentage point in the past month, more than South Africa or China, according to prices compiled by Bloomberg. Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent if a borrower fails to adhere to its debt agreements.

Yield Spread

The extra yield investors demand to own Brazilian government dollar bonds instead of U.S. Treasuries was unchanged at 228 basis points at 9:30 a.m. in New York, according to JPMorgan’s EMBI Global index.

Behind the protests is a growing concern with inflation, said Alexandre Barros, managing partner at Early Warning, a Brasilia-based political-risk consulting firm.

“The main thing people are feeling is that prices are rising at a pace they haven’t since inflation targeting began” in 1999, Barros said in a telephone interview. “It’s good for the government to make a change, because playing dumb won’t get them anywhere.”

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