Morgan Stanley sees Brazil economy slowing down less than expected

That engagement has already translated into some inflows into Brazil’s fixed income and currency markets, supported by the wide interest rate spread with the United States. Equities are also seeing movement, but at a smaller scale.

In Mr. Zema’s view, foreign investors are interested and beginning to position themselves while waiting for two main triggers to enter Brazil more decisively: a rate cut, which would favor equities, and a stronger fiscal commitment either from the current administration or from the candidates in the 2026 presidential election.

“In this world we’re entering now, with declining interest rates and Brazil still offering a relatively large spread, we should be attracting proportionally more flows than we are. If we implement or at least signal stronger fiscal adjustments, we will see much larger volumes coming into Brazil,” he said. Below are key excerpts from the interview:

Valor: U.S. interest rates have started to fall while Brazil’s Selic remains at 15%. What does this mean for Brazil?

Alessandro Zema: The macro picture has been relatively positive. Over the past four years, the economy grew more than markets expected. Inflation is decelerating, and prospects for rate cuts in Brazil are becoming increasingly likely. Currency volatility has also fallen significantly. This relatively benign scenario, with lower rates ahead, will bring some relief on the fiscal side and better growth prospects for next year. The major concern remains debt sustainability.

Valor: Markets expect a fiscal adjustment after the 2026 election, regardless of the winner. Do you agree?

Mr. Zema: Treasury Secretary Rogério Ceron told Valor he expects conditions for a stronger fiscal adjustment in 2027. Planning Minister Simone Tebet has also said this. The market increasingly expects a post-election adjustment.

Valor: That sounds like a meeting with the inevitable…

Mr. Zema: That’s how the market sees it. This adjustment could come through administrative reform, revenue and expenditure decoupling, or greater budget flexibility, but the expectation is that it will happen after the election.

Valor: We’ve seen inflows into Brazil, especially into bonds. Will they grow as the spread widens?

Mr. Zema: On the fixed-income side, with likely rate cuts ahead and a higher risk premium between U.S. and Brazilian yields, flows into Brazil are the strongest we’ve seen in years. Most of it has gone into foreign exchange rather than bonds. The long end of the curve is still very high, but as rates fall, we may see more bond allocations. Equities are a different story. Outflows from multimarket [hedge] and equity funds have slowed sharply since the start of the year, which is very positive. Brazil is cheap. We haven’t seen foreign investors selling Brazil. Any reallocation abroad that flows here is having a strong price impact.

Valor: What’s missing for stronger equity inflows?

Mr. Zema: Foreign investors don’t lack conviction or risk appetite. What’s missing are catalysts, mainly fiscal ones, to bring larger volumes. The first step, which is having investors more engaged and following Brazil closely, is already happening. At our September equity conference in London, with 63 Latin American companies and 250 global EM funds, the meeting agendas were completely full. Interest is strong, but greater visibility is still needed for a real equity flow.

Valor: Is this investor reallocating from the U.S. to emerging markets?

Mr. Zema: Yes. We’re seeing global reallocations into Brazil and Latin America that are moving prices. But I wouldn’t say there’s a strong directional flow specifically into Brazil yet. We’re not seeing foreign investors selling Brazil either. Falling U.S. rates and the prospect of cuts here too have been very positive for emerging markets. The MSCI EM index in dollars is up 25% this year. In Brazil, it’s up 35%.

Valor: Despite Ibovespa’s record highs, trading volume is at multi-year lows. Would a fiscal adjustment spark a rally?

Mr. Zema: Absolutely. In this world of declining rates and Brazil still offering a relatively large spread, we should be attracting proportionally more flow. So yes—if we implement or at least signal stronger fiscal adjustments, volumes will grow significantly.

Valor: How large would the adjustment need to be to unlock inflows? Would signaling be enough, or would investors demand concrete measures?

Mr. Zema: Signaling and a gradual execution plan are crucial. I can’t say how much adjustment is needed. What truly stabilizes debt is a primary surplus above 3%. Whether any government will deliver that, I can’t say. But the willingness to do so will matter a lot.

Valor: We have seen a stronger volume of debt issuance abroad this year. Is this also a reflection of foreign investors’ interest?

Mr. Zema: Up to this moment, we have had $29 billion in issuance from Brazilian companies. And we expect at least another $10 billion by the end of the year. This volume is much larger than last year, and many Brazilian issuers are raising funds with spreads over U.S. Treasuries at historical lows. In equities, when we think of the U.S. market, which is the most liquid in the world, since July we had not seen a sequence in terms of quality and quantity [of IPOs] as good as in the last four years. We have seen much more constructive markets. The offerings not only priced very well but the shares also performed very well afterward. This, obviously, is an important catalyst for future transactions to come to market. In these last ten days, we saw $15 billion in issuances in the U.S. in 27 different transactions.

Valor: Does this movement help reopen IPO activity in Brazil?

Mr. Zema: In Latin America as a whole, we live very much by windows [for IPOs]. What we see happening now in Brazil is that, due to these more constructive markets abroad and the prospect of rate cuts here, companies are at least beginning to think about the possibility of coming to market. Considering the possibility of coming to market requires not only constructive global markets but also visibility of a larger rate cut than currently forecast. Today, the market is expecting around three percentage points of rate cuts from the beginning of 2026 to the beginning of 2027. Empirically, when you look at the statistics, most IPO volume, follow-ons, and equity activity in general in Brazil happens when the real interest rate is below 6%. So we would need to reach a nominal rate of perhaps around 10% and a real rate below 6% to actually have the conditions to start seeing IPOs and successful offerings.

Valor: So, it is not something we can expect even in 2026…

Mr. Zema: No, I hope we will see it in 2026.

Valor: The Selic is not expected to reach that level next year…

Mr. Zema: Morgan Stanley’s view is that this very resilient pace of economic activity will slow down more gradually than the market imagines. In our view, rate cuts begin in March, but from then on they are much sharper. We are pricing in a rate of 11.5% by the end of next year. The market is pricing that the cuts start a bit earlier, but not as sharply. And with inflation decelerating, the exchange rate stable, and sharper rate cuts, all of this creates a very positive environment for Brazil’s capital markets, both equity and debt.

Valor: This will coincide with an election year. Won’t companies hold back their operations?

Mr. Zema: Without any doubt, it depends very much on the visibility of what the day after the election may look like. In general, local investors follow this electoral theme very closely, and it is 100% on their radar. For foreign investors, not so much yet. They will start paying more attention later on.

Valor: Here, it is the big topic…

Mr. Zema: Abroad, it is not such a big topic yet. It will be, but not yet. Fixed-income investors are looking at a very large spread and risk premium for Brazil, and they are coming here in very significant volumes. Equity investors are saying, “Well, Brazil is cheap, I am engaged, I am trying to understand, but I need greater visibility and some fiscal catalyst to actually come in with larger volumes.” There are so many things going on… Imagine yourself, an emerging markets investor who is allocated in China, India, Mexico, Brazil, South Africa, Russia, etc. You are following so many themes that Brazil’s election, in October next year, can wait a little longer before being followed that closely. The Trump government anticipated an agenda with very strong items—cost reduction, immigration, tariffs—and only now are we starting to see an adjustment. So, investors have re-engaged to follow Brazil, they have risk appetite. I mentioned the conference last week [the week before last]. If we had held it four months earlier, the level of engagement would have been half of what it was. So, investors are engaged, they have risk appetite to come to Brazil. They do not yet have great conviction, but that conviction should come.

Valor: In recent years, the performance of the U.S. market has outpaced the rest of the world. Is there now more room for emerging markets?

Mr. Zema: I have no doubt, with the depreciation of the dollar against other currencies and a reallocation happening from the United States to other markets. In the world equity market, 67% of all volume is allocated to the United States. The second largest is Japan, with 4%. Any 1% that leaves the U.S. makes an enormous difference for several markets. Investors are seeing lower growth in developed economies and higher growth here. It is definitely a trend.

Valor: Do tariffs and other sanctions imposed by the U.S. worry foreign investors?

Mr. Zema: At the beginning, it was a very big concern, but it became clear that, as Brazil is a relatively closed economy, with exports to the U.S. accounting for 12% of GDP, and since many items on the agenda, after those two or three weeks when we were in the dark, were exempted, the effective impact on GDP is somewhere between 0.1% and 0.2%. So there was a certain relief among investors and economic agents that the tariff impact would not be as large as initially imagined when the news first broke. The concern now is whether tensions will escalate and change what has already been priced in.

Valor: Is there no fear that Brazil is isolating itself from the world?

Mr. Zema: I don’t think so. Of course, it would have been much better not to have had [the tariff hike] than to have had it, but I did not get the feeling that Brazil is isolating itself from the world.

Valor: Do you think the recovery of equities will already begin to show this year, or only when the Selic falls?

Mr. Zema: The clearer it becomes that rate cuts will happen earlier and in a sharper or stronger way, the greater the predisposition to see investors coming here. And if there is good news or fiscal catalysts, that accelerates the movement. It does not necessarily need to wait until after the election. Positive government signals on the fiscal side will be of enormous help in generating stronger flows.

Valor: You mentioned companies starting to move toward IPOs. What is their profile? Large tickets?

Mr. Zema: That’s the profile. One thing we saw in the last Brazil cycle, which happened in 2019, 2020, 2021, was transactions with book prices in which 70% to 80% of investors were domestic. We saw that huge migration out of fixed income into equities. In this new phase, we will no longer see 70% or 80% domestic bookings. We will probably see balanced books between domestic and foreign investors, 50% to 50%, with a larger share of foreign investors.

Valor: How is the M&A market?

Mr. Zema: We have seen as a major trend Brazilian and foreign companies rebalancing portfolios to reduce leverage. Some large foreign companies are divesting assets in Brazil due to leverage at headquarters, and Brazilian companies are also rebalancing their portfolios. The volume of M&A transactions this year should be higher than last year, and we should see a better 2026 than this year. It is a positive trend.

Valor: What is the profile of these transactions?

Mr. Zema: They are generally larger, and many involve share swaps. In periods with interest rates as high as they are now, it is more difficult for companies to have the conviction to raise debt in the market to finance an acquisition. So if the stock price is at a healthy level, they prefer to use shares rather than debt. In many transactions, what has happened are share swaps.

*By Talita Moreira and Gabriel Roca — São Paulo

Source: Valor International

https://valorinternational.globo.com/