Brazil Economic Team Enlists Investor Help as Rate Bets Soar
(Bloomberg) -- Brazil’s economic team is enlisting investors to help it defend a rule that caps public spending, as growing fiscal concerns sink local markets and push traders to bet on the most aggressive interest rate hike in a decade.
Members of Economy Minister Paulo Guedes’s crew and the Treasury have asked fund managers and economists to publicly defend the so-called spending ceiling that limits the growth in public expenditures to the inflation rate, according to three people with knowledge of the matter who asked not to be named as the information isn’t public.
The move comes after senate leaders pushed to remove the Bolsa Familia social program from that rule, just as congress prepares to approve a second round of cash handouts to the poor following a record fiscal deficit in 2020. Growing challenges to Guedes’s austerity drive have been raising investor concerns about the minister’s future in the administration.
The Brazilian real is down more than 8% this year, leading led losses in emerging markets even as the central bank repeatedly steps in to prop it up, including with two spot dollar sales on Tuesday. Stocks have slipped more than 6% in 2021, underperforming almost all major peers.
The deterioration has led to a spike in swap rates, which are now implying chances the central bank increases the benchmark rate by 75 basis points on its March 17 meeting. If confirmed, it would be the biggest move since 2010.
“There’s a chance the scenario will deteriorate so much until the next meeting that a 50 basis point hike would seem dovish,” said Solange Srour, chief economist at Credit Suisse in Brazil.
The selloff comes as a string of negative headlines turns investors more pessimistic on the outlook for fiscal accounts, the reform agenda and the impact of the pandemic on activity. A continued rise in Covid-19 cases across the nation is threatening to push hospitals to a collapse, leading state governors to announce a fresh round of restrictions. That, in turn, is increasing pressure on congress to approve more financial aid to the poorest.
Discussions on the bill that would unlock the cash handouts are another source of concern to investors, who fear lawmakers will scrap planned compensatory fiscal measures to balance the impact of the additional spending.
The draft of the so-called emergency bill, presented on Tuesday, kept expenditures on education and health care earmarked, contrary to what Guedes had proposed. It also didn’t include other measures the minister had backed, such as decreasing workload and salaries, or freezing lawmakers’ amendments to the budget.
On the other hand, the text set triggers that seek to guarantee a ceiling will be in force when mandatory spending exceeds 95% of the total primary expenditure. It also keeps fiscal compensations tied to the emergency aid, easing concern the matters would be split into separate bills that could leave austerity measures on the sidelines.
“The selloff in both short-end rates and the currency is more related to risk premium and fiscal outlook uncertainty,” said Juan Prada, a currency strategist at Barclays in New York.
Investors are also fretting over whether Guedes will stay in office. While President Jair Bolsonaro publicly praised his economic czar last week, the minister’s influence over the agenda has weakened amid the Covid crisis. Bolsonaro’s decision to replace the chief executive officer of Petrobras last month, and his announcement Monday of a cut on diesel and cooking gas prices have further fanned concerns over Guedes’s fate.
The minister said in an interview that aired Tuesday morning he’d rather step down than take the government into the wrong direction. Brazil risks becoming Argentina in six months and Venezuela in a year and a half if it strays from austerity, Guedes said.
“With the flurry of risks in the horizon, news stories about Guedes remaining as the Minister of the Economy (or not), could disturb markets further,” Citigroup economists led by Dirk Willer wrote in a note. “Investor optimism will remain suppressed after the government’s meddling to prevent a rise in fuel prices, and the potential dilution of compensatory measures in the emergency bill.”
Rate Hike Bets
Swap rates soared on Tuesday, with the longer end of the curve up more than 20 basis points. That has led the curve to imply a 60 basis point increase in borrowing costs this month, which means the market is fully pricing in a 50 basis point hike and sees a 40% chance of a 75 basis point move.
The last time the central bank increased rates by that much was in mid-2010, amid a tightening cycle that pushed the Selic benchmark rate to 12.25%. Over the past few years, borrowing costs have consistently fallen, reaching the current all-time low of 2%.
While some investors say the recent move is exaggerated, consensus is growing that officials will have to deliver at least a half-percentage point hike in March.
“The window for a 25 basis point move has definitely closed,” said Bruno Carvalho, a fixed income trader at Asset 1 in Sao Paulo.
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