Medium-term NTN-B rates surpass 6.7% amid uncertainty and Selic tightening cycle

10/09/2024

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Growing distrust in fiscal policy, combined with the beginning of the monetary tightening cycle, has led to a sharp rise in real market interest rates, reflected in B-Series National Treasury Notes (NTN-Bs)—Brazil’s inflation-indexed bonds—which are now nearing the psychological 7% mark for some maturities. At Tuesday’s (8) weekly National Treasury auction, three-year bond (May 2027) rates hit 6.709%, raising concerns about the government’s increasing financing costs and worsening debt structure.

The recent spike in real market interest rates mirrors stress levels last seen in early 2016 during Dilma Rousseff’s administration.

“Brazil has experienced fiscal distortions and some uncertainty around the Central Bank, but the latter is being addressed,” said Luciano Rais, head of fixed income at Santander Asset Management. However, he warned that the fiscal risks continue to rise. “The current agenda is more focused on boosting revenue rather than cutting spending,” he added.

“The market is mainly suspicious of the structural side. While the deficit is a key concern, it’s being tackled with temporary revenue sources, whereas spending increases appear permanent,” Mr. Rais continued. He also noted that despite restrictive interest rates, economic growth remains strong, which is a concern for the Central Bank as it resumes its tightening cycle.

“The Central Bank’s rate hikes are impacting NTN-B and fixed-rate bond yields. Although longer-term NTN-Bs offer attractive yields, these higher rates don’t seem unjustified. Expected real interest rates will need to rise further,” Mr. Rais explained.

Ronaldo Patah, Brazil strategist at UBS Global Wealth Management, agreed that fiscal uncertainty and the recent monetary tightening have fueled the surge in NTN-B rates. He pointed out that while U.S. Treasury movements have been more restrained—with the real U.S. 10-year rate rising only slightly from 1.74% at the beginning of the year to 1.77% now—the Brazilian 10-year NTN-B rate has soared from 5.4% to 6.5%.

Mr. Patah added that even if the government meets its primary fiscal target for this year, lingering doubts over whether it can achieve a zero deficit next year are contributing to a roughly 100-basis-point increase in real interest rates as risk premiums become embedded in bond prices.

“Without new measures and relying on non-recurring revenues like this year, the expected deficit for 2024 is 0.8% of GDP—well short of the zero target,” warns Mr. Patah, noting the possibility that the government may need to revise its fiscal framework targets. Such a revision could worsen the perception among financial agents, potentially driving real interest rates even higher.

Mr. Patah points to two negative signals on the fiscal front: the government’s push to extend the gas allowance and its proposal to exempt individuals earning up to R$5,000 a month from paying income tax. However, he acknowledges that Moody’s upgrade of Brazil’s sovereign rating, with a positive outlook, might encourage the government to pursue fiscal balance to reclaim its investment-grade status.

Amid these challenges, Luiz Alberto Basqueira, partner and head of fixed income at Ace Capital, sees a negative bias in medium- and long-term real interest rates. His concerns center on Brazil’s public debt trajectory and the recent deterioration in its structure. “We don’t like the level of nominal interest or real rates, particularly in the medium and long term. This is a bias, and we are reducing our exposure to these parts of the curve,” he explains.

Mr. Basqueira also highlights potential external pressures on rates. He suggests that the U.S. Federal Reserve, which has started its monetary easing at a pace of 50 basis points, may not be able to deliver the number of rate cuts the market anticipates. Additionally, with Donald Trump remaining a frontrunner in the U.S. presidential race, Treasury yields could face upward pressure, which would likely spill over into the Brazilian market.

According to Mr. Basqueira, Ace Capital’s strongest conviction in the interest rate market comes from a more pessimistic outlook on inflation. “Beyond structural factors like strong economic activity, a tight labor market, exchange rate fluctuations, and unanchored inflation expectations, we see heightened risks linked to climate issues such as heat and drought. We are particularly pessimistic about food inflation, which we expect to reach 8% this year and 7% next year—well above market projections,” says Mr. Basqueira, adding that he favors long positions (betting on the rise) in short-term “implicit” inflation.

Mr. Basqueira also highlights that competition for funds with the credit market is another factor pressuring medium- and long-term real interest rates. “The demand for hedging from credit funds has contributed to the upward pressure on the real interest rate curve,” he explains.

Moreover, the substantial issuance of incentivized bonds has negatively impacted government bonds. “In addition to the competition, the government misses out on revenue due to the tax exemption for these bonds. They undeniably divert resources that could help finance public debt,” he notes.

As of last month, NTN-B issuances made up just over 10% of the total for the year, as the National Treasury has chosen to focus on selling post-fixed Financial Treasury Bills (LFTs), which are tied to the Selic, Brazil’s benchmark interest rate. This shift has raised concerns among market participants about the composition of the public debt.

“If the government believes that current interest rates are too high and expects them to fall, it makes sense to shorten the debt by selling LFTs, which are indexed to the Selic rate. In a rate-cutting cycle, the cost of the debt would drop quickly. However, if the debt is shortened and the government fails to regain fiscal credibility, the debt structure becomes more vulnerable,” warns Mansueto Almeida, chief economist at BTG Pactual and former Treasury secretary.

“You shift from long-term financing, like the NTN-B, to shorter-term financing with LFTs, which have a maturity of up to six years. This creates a more fragile debt structure,” explains Mr. Almeida. “Selling an NTN-B at a 6.5% interest rate is very expensive. If the government is confident it can take steps to demonstrate its commitment to fiscal policy and bring down that interest rate, it might make sense. But if those actions don’t materialize, if market doubts persist, and if long-term rates remain at this elevated level, the government will be adding to the fragility of its debt financing.”

Mr. Rais, from Santander Asset Management, adds that there is ongoing debate among market participants over whether the Treasury is facing a lack of demand for NTN-Bs or is simply unwilling to accept the high market interest rates. “If the Treasury has demand but chooses not to issue NTN-Bs due to the high rates, it may be a risky move to leave the debt more exposed to post-fixed rates,” Mr. Rais says, highlighting the potential risks if the Selic rate needs to rise further.

*By Gabriel Roca, Gabriel Caldeira, Victor Rezende — São Paulo

Source: Valor International

https://valorinternational.globo.com/