Analysis: Brazil’s risk premium soars after Congress breaches spending cap

BRASILIA, July 22 (Reuters) – Brazilian bond markets are pricing in the highest levels of risk in years, raising red flags among investors and government officials who see little relief in sight.

As global interest rate hikes and recession risks have put all emerging markets under pressure, Brazil is under particular scrutiny after Congress opened a constitutional spending cap to allow for a blowout. election year expenses. Read more

“The problem is the change in the spending cap,” said an official from the economy ministry, who spoke on condition of anonymity to discuss the situation openly. “This weakens the reading that the fiscal situation will be under control in the years to come.”

Even with positive surprises such as strong June tax revenue data on Thursday, the official said Brazil’s yield curve remains under pressure as investors brace for the worst. Read more

The two main candidates for the presidential election in October – the left-wing former President Luiz Inacio Lula da Silva and the right-wing incumbent Jair Bolsonaro – have announced their intention to extend this year’s increase in social spending until the end of the year. ‘next year.

“It’s a tax bomb,” said Sergio Goldenstein, chief strategist at Renascença DTVM. “Risk premiums look high, but there is little room for meaningful downside.”

The real rate on inflation-linked government bonds is at its highest since late 2016, while Brazil’s five-year credit default swaps are at highs last seen at the start of the pandemic in March 2020.

Concerns over Brazil’s credit profile come as commodity shocks from the war in Ukraine rattle the global economy and contribute to inflation, prompting rich countries to start raising interest rates.

“All credit spreads in the world are opening, our bonds are no exception,” said Ronaldo Patah, chief strategist at UBS Consenso.

In fact, Brazil’s strong grain, oil and iron ore exports give it some advantages over other emerging markets that are weathering the current commodity price spike, regardless of the political risks in Brasilia that are now shaking investors.

Brazil’s central bank also started raising rates early against most of its peers, raising its benchmark interest rate from an all-time high of 2% in March 2021 to 13.25% currently, with a another hike planned for August to curb double-digit inflation.

Most of the market is therefore betting on growth-supporting rate cuts from the middle of next year. However, risk premia now point to rates above 13% on the yield curve for maturities ranging from 2024 to 2033, while mid-2023 highs point to a cumulative rate above 14%.

“I am struck by this flattening process (of the yield curve) that we are seeing at a very high level,” said Ativa Investimentos chief economist Etore Sanchez.

Roberto Dumas, chief strategist at Banco Voiter, said Brazil is caught between a central bank tightening rates while the government finds new ways to increase spending.

“The more one accelerates, the more the other needs to brake. Everyone is projecting more and more that the Selic is going to rise more than expected,” said Dumas, who forecasts the benchmark rate at 14.25% at the end of this year. .

Reporting by Marcela Ayres and Jose de Castro Editing by Brad Haynes

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