Brazilian Real, Stocks Slump as Brexit Adds to Deficit Concern

  • International investors boost bearish bets on currency
  • Petrobras, Itau, Vale contribute most to Ibovespa’s decline

Brazil’s real and stocks joined a global selloff after Britain’s vote to leave the European Union spurred concern the recession in Latin America’s largest economy will deepen amid a widening budget deficit.

The Ibovespa sank 2.8 percent to 50,105.26 on Friday as all but two of its 59 stocks retreated. Oil producer Petroleo Brasileiro SA, lender Itau Unibanco Holding SA and miner Vale SA led losses. The real fell 1.1 percent to 3.3748 per dollar as foreign investors increased wagers this week on the currency’s decline. Brazilian dollar-denominated bonds due in 2025 dropped, while the cost to hedge the nation’s debt against losses using credit-default swaps surged the most in three months.

Emerging-market assets tumbled after Britain’s vote to exit the EU drove the pound to the lowest level in more than 30 years and European banks to their steepest losses on record, spurring a flight from riskier assets. The premium investors demand to hold sovereign debt from developing nations rather than U.S. Treasuries increased by the most since June 2013. The selloff added to concern the global economy will weaken at a time when Brazil is already facing its worst contraction in a century.

“When markets get very risk averse, a country like Brazil is hit more than a country with better economic and political outlook,” said Georgette Boele, an analyst at ABN Amro Group NV in Amsterdam.

While Brazilian exports to the U.K. accounted for only 1.5 percent of the South American nation’s total trade, the impact of Brexit on sentiment is seen placing emerging-market countries with large current-account deficits at a more vulnerable position. A pronounced flight to safety could end up putting even more pressure on high-yielding currencies, according to Mike Moran, the head of economic research for the Americas at Standard Chartered Plc. That would happen at a time when Brazil is trying to shrink a near-record budget deficit that cost it an investment-grade credit rating and eroded confidence.

That global risk aversion also casts doubts on the outlook for foreign investments in Brazil’s financial markets after both stocks and the real led world gains this year amid prospects that a new administration would be able to revive growth.

Foreign investors have boosted their bets against Brazi’s real in the futures market to $21.5 billion from a more than two-year low in April, according to data compiled by Bloomberg and BM&FBovespa SA. Analysts surveyed by Bloomberg predict the currency will drop about 10 percent to 3.75 per dollar by year end. Meanwhile, the participation of international investors in the nation’s equity trading has risen to a record of 53 percent after $12.9 billion was put into local equities this year, data from the exchange show.

“Market participants are fleeing risky assets and buying safe-haven ones, waiting for the smoke to clear,” said Arnaud Masset, an analyst at Swissquote Bank SA in Gland, Switzerland. “The Brexit will not help to improve the global outlook as the global economy is already going through a turbulent period.”

The selloff in Brazilian assets also represented an unwinding of the gains earlier this week, when the appetite for risk increased as bookmakers’ odds suggested the chance of a so-called Brexit was less than one in four. Both the Ibovespa and the real are still up about 1.2 percent since last Friday.

After a pronounced selloff in early trading, the real trimmed losses amid bets central banks of developed countries will continue with lower borrowing costs to cushion against shocks. Prospects for policy support should help calm the mood in financial markets and ultimately limit capital flight from developing nations, according to Neil Shearing, the chief emerging-markets economist at Capital Economics Ltd. Yet for some traders, currency strategies that seek to benefit from rate differentials -- known as carry trades -- are not as attractive during a worsening of the global economic outlook.

“Lower global rates do generate support for the real,” said Mauricio Oreng, a senior strategist at Rabobank in Sao Paulo. “But the high interest-rate differential would not outdo the effects of an increase in risk aversion, should a global recession take place.”

All 10 groups in the MSCI Brazil fell, led by energy and raw-material companies. State-controlled Petrobras and iron-ore miner Vale tumbled at least 4.3 percent. Lender Itau led a plunge in financial companies.

Even after Friday’s slump, the Ibovespa is trading at 11.6 times estimated earnings or 6.5 percent above its five-year average. The gauge’s current valuation is in line with the multiple for emerging-market stocks.

Brazilian swap rates on the contract maturing in January 2018, a gauge of expectations for interest-rate moves, reversed earlier gains and dropped 0.02 percentage point to 12.64 percent. Brazil’s Acting President Michel Temer said he hopes borrowing costs will fall this year, as his administration struggles to revive growth, newspaper Folha de S. Paulo reported.

The central bank has kept the benchmark rate at 14.25 percent, the highest since 2006, for seven straight meetings. While the policy hasn’t succeeded in bringing near double-digit inflation to the official target of 4.5 percent, it has contributed to a recession that is fueling unemployment and damping consumer confidence.

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