NTN-B rate climbs to a 14-month peak amid fiscal deterioration and external pressures

06/10/2024

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Fabricio Taschetto — Foto: Rogerio Vieira/Valor

Real long-term interest rates have settled at around 6% for the past two months, reaching a 14-month high with no indication of decline. This uptick aligns with a global context of rising interest rates, notably in the United States, and is compounded by a deteriorating perception of risk and growing uncertainties surrounding government accounts.

The fiscal measures adopted by the government have not helped alleviate these rates. Recent taxation changes affecting exclusive or restricted closed-end funds have prompted investors to shift their capital towards tax-exempt securities, thus increasing demand for long-term NTN-Bs (B-Series National Treasury Notes, Brazilian government bonds indexed to the national inflation rate), which are generally less influenced by monetary policy cycles.

Notably, the real interest rates indicated by long-term NTN-Bs starkly contrast with those during the last cycle of the Selic rate (Brazil’s benchmark interest rate) cuts. In 2020, rates for bonds maturing in 2045 fluctuated between 3.5% and 4.5%. Now, those same securities are yielding rates above 6%. This significant shift reflects both the deteriorating state of government accounts over the past four years and the tightening of monetary policy in the United States.

In recent weeks, Brazil’s financial markets have shown increasing independence from U.S. trends. The gap between Brazilian and American real interest rates has widened significantly, suggesting that the market is demanding a higher premium to hold Brazilian bonds.

“Rates are undoubtedly high. From a fiscal standpoint, it appears unsustainable,” observes Michael Kusunoki, the head of fixed income and multimarkets at BNP Paribas Asset Management. He emphasizes that Brazil is at a pivotal moment. “We are facing challenges with the credibility of its fiscal and monetary policies. There is a perception of leniency in both areas, which undermines confidence and necessitates higher risk premiums from the market,” he adds.

Despite a recent easing of U.S. interest rates, this relief has not extended to the Brazilian market. Mr. Kusunoki points out, “The external environment offered some support, but the domestic factors failed to contribute positively. If the international situation were worse, the local scenario could be even more dire.” As of Friday, the rate for the NTN-B bond maturing in May 2045 was recorded at 6.3%.

Real long-term rates are expected to remain elevated for the foreseeable future, influenced by fundamental economic factors, fiscal deterioration, and persistent uncertainties. Renan Rego, chief investment officer at G5 Partners, notes that complexities such as changes in the Central Bank’s leadership and increased government spending contribute to the heightened levels of NTN-B rates. “The market is naturally adjusting, and this adjustment is compounded by technical issues related to investment flows,” he explains.

Mr. Rego observes that NTN-Bs have recently encountered increased competition, leading to reduced demand for these Treasury bonds. Consequently, interest rates on these securities have risen as the market adjusts to make them more appealing to investors.

“The taxation of come-cotas [mandatory withholding of income tax on investments] has significantly impacted closed-end funds, which traditionally held allocations in non-exempt assets like NTN-Bs,” Mr. Rego continues. “As taxation takes effect, investors face a tax burden on accumulated earnings, prompting them to shift their investment strategies towards managed portfolios with exempt securities. This shift has resulted in decreased allocations to NTN-Bs.”

The shift in investment strategies has thinned the pool of buyers for NTN-Bs, particularly at a time when the multimarket sector is experiencing volatility. “Multimarkets have traditionally purchased NTN-Bs when they perceived the pricing to be favorable. However, significant redemptions within the multimarket sector have notably decreased the demand for this asset, contributing to persistently higher rates.”

This perspective is echoed by Fabricio Taschetto, chief investment officer at Ace Capital, who attributes the sustained high levels of real long-term interest rates primarily to technical flow factors. “The government’s decision last year to alter the tax regime for exclusive funds disrupted the decades-long-standing equilibrium in the market for funds and bank bills. The imposition of taxes on the accumulated earnings of closed funds has freed up capital, prompting a shift towards tax-exempt alternatives. This has resulted in a significant migration of investments,” he observes.

Mr. Taschetto also notes that, as NTN-Bs underperform, funds linked to the IMA-B—an index of inflation-linked government bonds—are similarly struggling, leading to a cascade of redemptions affecting these funds as well. “Effectively, there are fewer financiers for public debt. The competition facing NTN-Bs has intensified alongside the surge in demand for exempt commodities, complicating the government’s efforts to finance its debt through these securities as capital flows into exempt investments. This results in a significant fiscal shortfall,” he explains.

Furthermore, Mr. Taschetto points out a unique challenge for NTN-Bs. “When managers of funds holding incentivized bonds receive contributions, they typically purchase IPCA-linked incentivized bonds and must hedge these positions. Generally, this hedge involves selling NTN-Bs short. Thus, capital exits funds that were allocated to NTN-Bs, necessitating their sale and is redirected to other funds where managers are again compelled to sell NTN-Bs. It results in a compounded negative impact on these securities.”

Ace Capital maintains a position in long NTN-Bs, albeit reduced. “Once we grasped the dynamics at play, our appetite for NTN-Bs diminished sharply, leading us to halve our holdings. Given the enduring nature of these technical factors, we plan to maintain our current positions until the market stabilizes. While NTN-Bs priced near 6.2% represent significant value, we do not foresee any immediate catalysts that would dramatically alter their status,” Mr. Taschetto adds.

Miguel Sano, a fixed-income manager at SulAmérica Investimentos, shares a similar pessimistic outlook on long-term real interest rates. “The premiums are steep on the long end, yet we see no catalyst for improvement. For instance, this week saw a significant drop in the yields of 10-year U.S. Treasuries, but neither the local market nor other emerging markets mirrored this movement.”

Mr. Sano explains that real rates have struggled to maintain a downward trend due to liquidity constraints, similar to those affecting other assets. “Purchasing requires available capital. Multimarket funds have experienced significant redemptions over the past eighteen months. Likewise, IMA-B funds and foundations have shown little interest. The market is missing a catalyst… We have long considered equities undervalued, yet there’s been no movement,” he states.

Additionally, Mr. Sano highlights that the attractiveness of NTN-Bs may be dampened by shifts in the neutral interest rate. “If the neutral interest rate is indeed higher, the potential for gains on these bonds diminishes,” he notes.

Mr. Sano also contemplates the likelihood of even higher interest rates. “Back in 2007, when Treasuries were around 4.7%, long-term NTN-Bs were trading at about 7%. We can’t discount the possibility of reaching those levels again if the economic outlook deteriorates,” he explains.

Lucas Queiroz, a fixed income strategist at Itaú BBA, notes a recent trend towards risk reduction in Brazil. “There’s been a notable correlation between interest rates and the exchange rate lately, indicative of classic risk aversion. This trend became particularly evident in April and May, as investors started unwinding their positions,” he observes.

Mr. Queiroz believes that the current interest rates incorporate considerable risk. “The Focus [bulletin] suggests that the market anticipates a real neutral rate of around 5%. If you hold an indexed bond over five years, you’d expect a return of five percent over the Consumer Price Index (IPCA+5%). Currently, NTN-Bs are offering about 6.2%. There’s a premium in play here, which is central to our optimistic outlook for a potential reduction in rates,” he concludes.

Por Victor Rezende, Gabriel Roca — São Paulo

Source: Valor International

https://valorinternational.globo.com/