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Rates surpass 12% after disappointing report, impacting exchange rate and stock market

09/24/2024


Maurício Bernardo — Foto: Rogerio Vieira/Valor
Maurício Bernardo — Foto: Rogerio Vieira/Valor

The market once again voiced concern over the state of government accounts, leading to the third consecutive session of pressure on futures rates, which reached their highest levels of the year and settled above 12%. Investors were disappointed by Friday’s release of the bimonthly revenue and expenditure report, which revealed a reduction in the previously announced R$15 billion spending freeze from July. With the perception of a less stringent fiscal policy, risk premiums surged, impacting future interest rates and the foreign exchange and stock markets.

During Friday’s session, rising risk aversion caused significant market stress, which only deepened on Monday. Brazil’s interbank benchmark rate, known as CDI, for January 2029 surged from 12.31% to 12.475%, hitting a session high of 12.575%. On the foreign exchange front, the FX rate neared R$5.60 per dollar but closed at R$5.5344, up 0.25%, while the benchmark stock index, Ibovespa, dropped 0.38% to 130,568 points.

“The reduction in fiscal efforts, announced earlier, sends a negative signal, especially in light of the growing primary deficit,” says Roberto Secemski, chief economist for Brazil at Barclays. “It suggests the government’s tendency to spend up to the maximum limit allowed by the fiscal framework, despite the pressing need for structural, long-term spending adjustments.”

According to Mr. Secemski, the current skepticism in the domestic market stems less from concerns about compliance with the fiscal framework this year and more from a broader lack of confidence in addressing “underlying vulnerabilities” and the “perception of weak commitment to the effective stabilization of public debt.”

This view aligns with that of Luiz Alberto Basqueira, partner and head of fixed income at Ace Capital, who believes that the primary factor behind the market’s recent downturn is a growing “distrust of fiscal policy.” “The market has been skeptical of fiscal policy for some time, but recent small measures and government announcements have accumulated, reminding investors of the persistent challenges with government accounts,” Mr. Basqueira notes.

He points to the Supreme Court’s authorization of additional extraordinary credits, last week’s income and expenditure report, and the announcement of the gas voucher program, which, while likely to be altered by the government, “has already left a scar.”

“This is all unfolding against a very unfavorable backdrop, with increased market concern over the debt-to-GDP ratio. The market is troubled by two things: the perception that the government is not committed to delivering the surplus needed to stabilize the debt and the fact that while the current target can be met, it would be achieved mainly through revenue-side measures, many of which are ‘one-offs.’ The market views this as a low-quality adjustment,” says Mr. Basqueira.

Compounding the negative fiscal outlook is the onset of a monetary tightening cycle, with the Central Bank’s recent communication taking a notably hawkish tone. “The high inflation projection in the reference scenario signals to the market that the interest rate path in the COPOM’s model—already factoring in a 100-basis-point rise in the Selic rate—will need to be more aggressive,” Mr. Basqueira adds. It’s no surprise, then, that Ace Capital has maintained its “long” positions on rising interest rates across the curve.

Both short- and long-term interest rates have been climbing steadily, reflecting the market’s expectation of a more aggressive tightening cycle. The Focus Bulletin, released on Monday, now projects a Selic policy rate of 11.75% per year at the end of January, while the market is already pricing in a rate of 12.75% by mid-next year.

Despite this surge in interest rates, the Brazilian real has not found support. Although the currency gained on Thursday, it has been heavily penalized in recent sessions due to rising risk perceptions.

“The fiscal issue remains the ‘Gordian knot’—the country’s unsolvable problem,” said Andrei Basilio, head of foreign exchange at XP Treasury. “The government missed a key opportunity to show it is addressing fiscal concerns seriously, not just in the short or medium term, but structurally.”

Mr. Basilio emphasizes that it’s not just the numbers in the report that matter, but the lost opportunity. “The Central Bank is clearly grappling with stronger economic growth, which pressures inflation and leads to rate hikes. We’re also seeing improved tax revenues driven by expansionary fiscal policy. This should have been the time to build a fiscal cushion, not the opposite.”

If there are no further negative surprises on the fiscal front and the government delivers on its medium-term promises, the real remains a solid bet, according to Mr. Basilio. “But right now, there’s a bitter aftertaste due to the bimonthly report, as reflected in the yield curve.”

In this context, Maurício Bernardo, fixed-income manager at Vinland Capital, finds the rise in market premiums “reasonable,” given the disappointment with the income and expenditure report.

He notes that the yield curve was already under pressure due to expectations of a higher Selic rate. Now, concerns about fiscal policy have reignited uncertainty, prompting investors to question whether an even larger rate hike, beyond the anticipated 50 basis points in November, might be necessary.

“The risk premium weighs on the exchange rate and fuels market speculation about whether faster monetary tightening might be required. If more tightening is necessary, why not act sooner? The market is factoring that in,” says Mr. Bernardo. Last week, the digital options market for the next Monetary Policy Committee (COPOM) meeting in November briefly priced in a minority chance of a 75 basis-point hike.

In Mr. Bernardo’s view, the market still has room to price in additional risk premiums on the yield curve, driven by expectations that interest rates may need to rise further or concerns over fiscal risks. “If we don’t see positive developments on the fiscal front or more favorable inflation and activity data, it’s reasonable for the market to continue pricing a premium above 250 bp,” he says, referring to the Selic rate the market currently projects for the end of the tightening cycle.

ASA’s head of multimarket, Filippe Santa Fé, shares a similar perspective, calling the recent behavior in the interest rate market “natural.” “He adds, “I don’t think it’s a matter of positioning or that the movement is exaggerated at this point. Perhaps the speed of the adjustment has attracted attention, but we’re clearly not at any extreme in pricing.”

*Por Gabriel Caldeira, Arthur Cagliari, Victor Rezende — São Paulo

Source: Valor International

https://valorinternational.globo.com/
Government signals of extra dividends and spending pressures challenge domestic sentiment

11/03/2024


Fernando Siqueira — Foto: Celso Doni/Valor

Fernando Siqueira — Foto: Celso Doni/Valor

The calm that has prevailed in domestic markets in recent months has given way to a deterioration in risk perceptions.

The absence of extraordinary dividends from Petrobras, President Lula’s request for more credit from state-owned banks, and his desire to discuss an increase in the spending limit weighed on Brazilian assets last week. The sum of these factors increased investors’ mistrust of the government’s future handling of economic policy.

There was already some uncertainty in the air before Petrobras’s balance sheet was released on Thursday. However, this was contained as Brazilian assets underperformed their peers. On Friday, however, the deteriorating risk sentiment spoke louder. The blow to Petrobras shares, which fell around 10%, dragged Brazil’s benchmark stock index down—the Ibovespa fell 0.99% that day and 1.36% in the week, to 127,071 points. The foreign exchange rate gained 0.97% in the session to R$4.9816 per dollar due to capital outflows.

“The market is already used to this kind of talk from the government, but this time it came in the form of an attitude,” said Cesar Mikail, variable income manager at Western Asset, referring to the announcement that Petrobras will not pay extraordinary dividends for now. “And after the event, you always put something in the price for the company. Now the market can increase the asset’s discount rate, which is reflected in share prices.”

Concerns go beyond the Petrobras effect, however, as agents look at the macro context. President Lula’s comments signaling an increase in spending and the deterioration in the president’s rating measured by an IPEC survey have fueled the climate of uncertainty in the market. The perception of increased fiscal risk caused long-term interest rates to rise on Thursday and Friday, contrary to what happened abroad. The rate on DI contracts maturing in January 2027 rose to 9.97% from 9.905%, and that for January 2029 rose to 10.435% from 10.34% at the close of trading.

“There were doubts about whether the government would respect market laws or be more profligate; whether it would interfere in state-owned companies or not. So far, it had been less bad than expected,” said Daniel Delabio, partner and manager at Exploritas, citing respect for the Central Bank’s autonomy and the maintenance of the inflation target at 3% per year. “Now that the government seems to be getting closer to the [fiscal] target, Lula is taking the position that he wants to change it so he can spend more. If you look at this and the Petrobras decision, it creates an environment of risk aversion.”

Economist Yara Cordeiro of Novus Capital agrees. She highlights the fiscal impact of Petrobras’s decision, as a significant portion of the state-owned company’s dividends would go to the government. “The budget doesn’t provide for extraordinary dividends, but even so, everyone was counting on it being something that could help. In addition, there are doubts about the funds that were expected via CARF,” said the economist in a podcast, referring to the reinstallation of the casting vote, which tends to favor the government in the Tax Appeals Administration Council (CARF).

“We had expectations, at least on the government side, that there would be no resistance from Petrobras to reach an agreement with CARF. The amount expected to be paid to the government was quite significant, possibly reaching R$30 billion … With this setback suffered by the minority shareholders in the decision on dividends, the agreement now seems more distant and may face more resistance within the board of directors,” he said. “Not to mention that it was perceived as an attempt by the government to interfere in the company.”

Fernando Siqueira, head of research at Guide Investimentos, recalled that the issue has been discussed since the 2022 election cycle. “But [Finance Minister Fernando] Haddad managed to avoid it. Now we are seeing signs of a more negative path, and this should be on the radar of investors, especially local ones, who are looking at the political issue with a magnifying glass and are starting to fear what might happen.”

For Luiz Fernando Araujo, managing director of Finacap, recent events show that the risk of investing in state-owned companies has increased. “It has even increased for some privatized companies. We saw, for example, how the government tried to influence the choice of Vale’s CEO.”

Por Augusto Decker, Arthur Cagliari, Victor Rezende — São Paulo

Source: Valor International

https://valorinternational.globo.com/