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Brazil’s Real Falls as Shock Senate Vote Fuels Fiscal Woes

Brazil’s Real Falls as Shock Senate Vote Fuels Fiscal Woes

The world’s worst and most volatile currency is again at the mercy of public accounts.

Brazil’s real fell as much as 2.1% on Thursday, leading declines among major currencies, after the Senate unexpectedly overturned a presidential veto, opening the floodgates for increases in public servant wages.

The currency later pared losses and was down 0.6% at 5.5935 per dollar after lower house Speaker Rodrigo Maia said he disagrees with the Senate decision. The veto was sent to the lower house for another vote this afternoon and, if rejected again, it may create 120 billion reais ($21.3 billion) in additional public expenditures through the end of 2021.

Brazil’s Real Falls as Shock Senate Vote Fuels Fiscal Woes

Spending more is everything Brazil’s Economy Minister Paulo Guedes wants to avoid. Fears that the country could breach the public spending cap, one of its most important fiscal anchors, sent financial markets on a tailspin earlier this week and even fueled speculation that Guedes could leave his post. Markets recovered later as President Jair Bolsonaro came into his defense.

“Fiscal risk is the big question in Brazil,” said Sacha Tihany, the deputy head of emerging markets strategy at TD Securities in Toronto, who was the most accurate forecaster for the real in the second quarter according to Bloomberg rankings. “I’m still relatively bearish on the real and see it trading back toward the May levels over time.”

The real breached the upper bound of the 4.80 to 5.50 per dollar long-term trading range on Wednesday and, beyond that level, it has no barriers before the all-time low at 5.97 per dollar reached in May.

The main hurdle for further currency weakness is the central bank, as policy makers sold $590 million in the spot market on Thursday. The real is down about 28% this year, more than any other currency in the world, and its one-month implied volatility is also the highest globally, surpassing even the Turkish lira.

“The market seems to still have fresh memories of the sharp selloff that we saw earlier in the year, even when the BCB was aggressively intervening,” said Agustin Sicouly, senior emerging-market currency trader for Latin America at Barclays Capital Inc in New York. “Appetite to own the Brazilian real has decreased considerably as fiscal accounts seem more compromised in the medium term.”

Volatility

Meanwhile, there are signs of intensifying volatility in the local rates market as well. Weak activity tied to increased fiscal risk prompted a steepening of the interest rate futures curve, with the long end rising more than 90 basis points this month.

BRAZIL INSIGHT: Spending Cap Holds Key to Economic Pandora’s Box

Thursday’s vote will test the Bolsonaro administration’s new alliance with a group of centrist lawmakers known as centrao. Some lawmakers may be unwilling to back the unpopular wage freezes with just three months left before municipal elections.

Leaders of four political parties with nearly half of the votes in Brazil’s lower house are working to uphold the presidential veto.

“I believe we will maintain the veto. We are working really hard to do so,” said Marcelo Ramos, a deputy-leader of a bloc that holds 156 of the 513 lower house seats.

The congressional agriculture caucus, which counts 244 lower house deputies as members, said in a statement on Thursday that it backs the presidential veto.

Postponing wage increases for some civil servants was a cornerstone of an agreement reached earlier this year that included billions of dollars in aid for states and cities amid the coronavirus outbreak.

©2020 Bloomberg L.P.