Ratings Ignored Brazil to Mexico Show S&P’s Actions OverdueBoris Korby and Sebastian Boyd
Brazil’s credit-rating downgrade by Standard & Poor’s is being ignored by bond traders.
Instead of rising, the extra yield investors demand to own Brazilian government dollar bond instead of U.S. Treasuries has narrowed 0.15 percentage point since S&P cut the country to the lowest investment grade. The spread is up just 0.01 percentage point to 2.24 percentage points since June 6, when S&P first put Brazil’s credit rating on review for a reduction.
It’s not just Brazil. Since Mexico was upgraded by S&P in December, the extra interest paid by the country on its debt is down just 0.07 percentage point. When S&P stripped the U.S. and France of their AAA grades in 2011 and 2012, borrowing costs dropped rather than rose. In almost half the instances, yields on government bonds fall when a rating action by S&P or Moody’s Investors Service suggests they should climb, according to data through 2012 compiled by Bloomberg on 314 upgrades, downgrades and outlook changes going back to the 1970s.
“The S&P downgrade was way, way overdue,” Michael Shaoul, the chairman and chief executive officer of Marketfield Asset Management LLC, which oversees more than $20 billion, said by phone. “If they downgraded Brazil 12 months ago, they would have had something useful to tell people. They waited so long that everybody had worked out what was going on.”
S&P cut Brazil one step to BBB- on March 24, saying sluggish economic expansion and President Dilma Rousseff’s expansionary fiscal policies are fueling an increase in debt levels. Fitch Ratings and Moody’s rate Brazil one level higher.
“Yields are a better indicator of where credit ratings are going than credit ratings are of where yields are going,” Lars Christensen, the head of emerging markets research at Danske Bank A/S, said by phone from Poland. “When Brazil was downgraded and no one reacted, it shows the market knew very well that Brazil was riskier than the rating indicated.”
About $50 trillion of assets are invested using ratings as a guide, of which 95 percent follows ratings from Moody’s, S&P and Fitch, according to a March 26 report from economists at UniCredit SpA, Italy’s second-biggest bank. The so-called Basel III rules for measuring banks’ capitalization encourage the world’s largest lenders to use credit ratings in setting their investment priorities.
Fitch cut Venezuela on March 25 to B, five levels below investment grade, from B+ after an 88 percent devaluation that fueled the best sovereign bond performance in emerging markets. Bond investors had welcomed the devaluation.
The government is selling its dollars for more bolivars than before, allowing it to cut its deficit by more than half, according to Barclays Plc research. Venezuelan sovereign debt has slipped just 0.1 percent since the rating cut.
“If there’s any country in the world where a devaluation has a profoundly positive effect on public finances, it’s Venezuela,” said Jan Dehn, the head of economic research at Ashmore Group Plc, which manages $75 billion in emerging-market debt. “It does nothing except export dollar products and after the biggest devaluation I remember, Fitch downgrades the rating. It makes no sense.”
Brazilian sugar company Grupo Virgolino de Oliveira has lost bond investors 36 percent in the past 12 months as the price of sugar tumbled. Its bonds due in 2022 trade at 56 cents on the dollar. Yet apart from a single change in outlook on March 24, none of the three companies that rate its debt have taken any action at all in the last year.
Moody’s assigns a B3 rating, six levels below investment grade, to GVO’s 2022 bonds, which yield 24.65 percent. It assigns the same rating to 2020 bonds from Macau-based gaming company Melco Crown Entertainment, which yield 6.42 percent.
S&P ranks Virgolino de Oliveira’s bonds a level higher at B, the same as Grupo Cementos Chihuahua bonds with a yield of 6.54 percent.
“Ratings should be evaluated on the basis of their correlation over time with defaults, not with short-run movements in market prices,” said Ed Sweeney, a spokesman for New York-based S&P. Press officials for Moody’s and Fitch didn’t immediately return calls for comment.
International Monetary Fund economists including John Kiff argued in a research paper last year that the ratings companies’ attempts to ignore economic cycles makes ratings less effective for predicting default. Once a borrower starts to weaken, they can suffer what Kiff and others called a “rating cliff” as ratings companies race to catch up with a deteriorating credit.