Exchange rate hits R$5.4 per dollar, long-term interest rates exceed 12%, and Ibovespa reaches yearly low amid growing investor pessimism

06/13/2024

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Eduardo Cotrim — Foto: Luciana Whitaker/Valor

Domestic assets in Brazil suffered from a fresh wave of risk aversion, reaching their lowest levels of the year. Comments from President Lula, who suggested that increased tax collection and lower interest rates could narrow the primary deficit, failed to reassure market participants. Additionally, the reinstatement of a Provisional Presidential Decree that restricts PIS and Cofins (social taxes) credits fueled concerns that Finance Minister Fernando Haddad is losing influence within the government, contributing to a broadly pessimistic sentiment across financial markets.

The foreign exchange rate ended the day up 0.86% at R$5.4066—its highest since January 4, 2023—peaking at R$5.42. Future interest rates jumped, with the market now anticipating a sharp increase in the Selic policy interest rate by year-end. Meanwhile, Brazil’s benchmark stock index Ibovespa fell below 120,000 points, dropping 1.4% to close at 119,936 points.

This heightened domestic anxiety contrasts starkly with the positive trends in global markets. In the U.S., lower-than-expected inflation data shifted focus away from immediate Federal Reserve actions, leading to a significant rally in U.S. stocks and a decline in both the dollar and Treasury yields.

“Before, we could even talk about U.S. interest rates, but now we have other reasons for our underperformance. What is at the heart of this is our fiscal issue,” said Luis Garcia, CIO of SulAmérica Investimentos, highlighting the need to confront domestic problems directly. “It’s effortless to find out where the problem lies.”

In Mr. Garcia’s view, following market tensions that escalated since Friday, there was an expectation for President Lula to publicly support Minister Haddad by acknowledging the fiscal challenges yet reiterating a commitment to fiscal targets. “What we saw today [Wednesday] was exactly the opposite. We saw the president saying that the country is going to grow and that, as a result, there will be more revenue and, therefore, no need to cut spending. It’s the opposite of what was expected,” he noted.

President Lula, speaking at the FII Priority Summit, an international gathering of leaders and executives to discuss investment opportunities capable of providing sustainable growth to countries, said his administration is “putting its house in order,” including government accounts. “Through increased revenue and reduced interest rates, we can decrease the deficit without hindering public investment capabilities,” the president stated.

“Things are still hideous in the local market, and we’re in a crisis. Several articles throughout the day said that Haddad was weakened, with friendly fire from within his own party trying to undermine him. Lula had the opportunity to defend the minister and his role in controlling public spending, but he didn’t do it,” said Luiz Eduardo Portella, partner and manager at Novus Capital. “We need Lula to come to Haddad’s defense and prime his intention to control spending. Otherwise, we won’t get out of this downward spiral,” he added.

Mr. Portella also commented on the broader international context affecting Brazil’s market positioning; a few months ago, Brazil was in an environment where it was enough “just not to do anything stupid” to be dragged along by a global improvement. “We seem to have hit a wall now. We need to do some homework and row in the right direction to get back in line with global markets,” he said.

This issue is compounded as global investors grow wary of emerging markets due to political changes in countries like Mexico, India, and South Africa. “Global investors look at these countries and simply choose to reduce their exposure to emerging markets. Why would they look at emerging markets if the American market is still at all-time highs?” Mr. Portella questioned.

A similar stance is upheld by Eduardo Cotrim, partner and manager at JGP, who shares insights into how his company successfully navigated recent market turbulence. He reveals their strategic positions, which included long bets on the dollar against the real and on rising long-term interest rates.

On Wednesday, the Interbank Deposit (DI) rate for January 2029 closed the session at 12.155%, marking the first time this year it crossed the 12% threshold.

“The emerging darlings were Mexico and India, where the elections disappointed. With the emerging class full of problems and doubts and the return on American fixed income at an all-time high, the notion that money could flow into Brazil is diminishing, particularly as there are significant concerns here regarding fiscal policy and uncertainties about the continuation of the fiscal framework,” points out Mr. Cotrim. He sees the return of the PIS/Cofins Provisional Presidential Decree as “emblematic.”

“Haddad’s agenda proposes no spending cuts and leaves the entire bill to the private sector. Eventually, the business community feels the strain, and that time has come. The costs are simply too high,” he explains, indicating general exhaustion with the government’s approach to maintaining public expenditure without cutbacks. “This dissatisfaction stems from the excessive spending. The expenses are substantially high, and as budget discussions approach, we’re yet to see a clear plan on fiscal management,” he adds.

Mr. Cotrim reveals strategic shifts in his own investment approach, saying he has zeroed out positions in Brazilian assets and currently sees no appeal in the real or domestic interest rates. “I have no appetite for it. We believe it’s still too premature to place favorable bets. Numerous uncertainties are lingering, and these issues aren’t unique to Brazil,” emphasizes the JGP manager.

He also points to necessary changes in the global financial sentiment that could potentially improve the local economic outlook. “The high interest rates in the U.S. have set a high benchmark for foreign investors to allocate risk in emerging markets, diminishing the appeal of riskier emerging markets investments. This reluctance is evident in the bond auctions and other investment activities. Moreover, the rising skepticism in the market due to Lula’s waning popularity and other local issues like the continuous disputes within COPOM and changes in Petrobras’s leadership add to the prevailing uncertainty,” states Mr. Cotrim.

It’s important to note that in Wednesday’s session, Petrobras’s common shares fell by 2.1%, and preferred shares were down by 2.41%, following comments by the company’s CEO, Magda Chambriard, indicating that the company will use “all resources to invest in Brazil.”

“Since the Bolsonaro administration, we’ve seen numerous changes in the presidency of the company but minimal actual change within the company itself. We’re observing these shifts in discourse cautiously, as this isn’t the first time we’ve encountered this scenario, yet we still believe it’s mostly noise,” stated Fernando Siqueira, head of research at Guide Investimentos.

Assessing the overall situation, he suggests adopting a more defensive stance until there’s clearer visibility, particularly considering the perceived weakening of Minister Haddad. “His potential exit might create room for increased government spending,” Mr. Siqueira commented. “Moreover, President Lula’s recent statements were poorly received as they suggest a continued misdiagnosis of the fiscal situation.”

Leonardo Monoli, managing director of Azimut Brasil Wealth Management, also highlighted concerns in the financial landscape. He criticized President Lula’s recent remarks for not addressing necessary spending cuts, which he believes significantly impacts market sentiment. “There is never any discussion on the spending side, but only on the side of increasing revenue,” Mr. Monoli noted.

“We’re going to have a complicated second half of the year, and my concern now is that we’re going into this second part of the year very badly positioned,” he remarked, referencing the Federal Reserve’s indications of only one interest rate cut this year. “We’ve wasted a first half of the year that is seasonally favorable for flows. The government has to act, or we could have a problem. We’re heading for it.”

*Por Victor Rezende, Matheus Prado, Gabriel Roca, Arthur Cagliari, Augusto Decker — São Paulo

Source: Valor International

https://valorinternational.globo.com/