October 10, 2016 / 6:36 PM / 2 years ago

'Junk' sovereign rating puts ceiling on Brazil bull market

SAO PAULO, Oct 10 (Reuters) - Brazilian financial markets are unlikely to repeat their dramatic rally in 2016 even if Congress approves a business-friendly reform agenda during the coming year, as asset values are nearly at the ceiling of the country’s junk credit rating.

Brazil’s bonds, stocks and currency have been among the best-performing assets in the world this year as investors welcomed promises by new President Michel Temer to pass measures capping spending and trimming public pensions.

Investors are now waiting anxiously to see if Temer can make good on those promises, but even if a fragmented Congress approves his ambitious reform agenda, analysts say there is little room for more dramatic rises.

“Brazil has gone a long way and much of the good news is already priced in,” said Viktor Szabo, a portfolio manager at Aberdeen Investments, who is reducing exposure to the Brazilian government’s dollar-denominated debt.

Promises of reforms have already made investors far more willing to lend to Brazil. Yields on 10-year Brazilian local-currency bonds narrowed by more than 500 basis points so far this year, setting off an accompanying “cost of capital” rally for stocks, according to Credit Suisse analysts.

Brazil’s five-year credit default swaps (CDS) , a gauge of default risk, paved the way for this year’s bull market by rallying to 264 basis points on Monday from nearly 500 at the start of the year.

That is below the average of 294 basis points for countries that share Brazil’s double-B credit rating from the three main ratings agencies, testing how far spreads can go for Latin America’s largest economy without an investment-grade rating.

The CDS of triple-B-rated countries trade as high as 240 basis points, as in the case of South Africa, and average around 140 basis points.

All three major agencies stripped the country of its investment-grade rating between September 2015 and February 2016.

Brazil is currently rated “BB”, “BB” and “Ba2” by Standard & Poor’s, Fitch Ratings and Moody’s Investors Services, respectively, all with negative outlooks.

Gabriel Gersztein, a strategist with BNP Paribas, said Brazilian CDS could fall to about 200 basis points by the end of 2017 if Temer’s fiscal efforts are successful.

That would put them in line with Russia, which is rated “BB+”, “BBB-“ and “Ba1” by S&P, Fitch and Moody’s, respectively.

“There could still be some improvement, but at a slower pace,” Gersztein said.

A Reuters poll of analysts forecast a 5.5 percent rise for Brazil’s benchmark Bovespa stock index to 65,000 points by the end of 2017 after a 42 percent rally so far this year.

A separate poll showed the Brazilian real weakening to 3.43 per dollar in the next 12 months, from 3.21 currently.

See graphic: tmsnrt.rs/2dPWWmg


Brazil reached investment-grade status for the first time in 2008, as a commodities boom and policies mixing fiscal restraint with social programs made the country an investor darling.

However, crashing commodity prices, a deep recession and big budget deficits have trashed that reputation in recent years.

A Fitch study showed countries that lost their investment-grade ratings took 6.1 years on average to recover them.

“At this juncture, we do not foresee Brazil returning to investment grade in the next two years,” Fitch’s Shelly Shetty, head of sovereign analysis in the Americas, told Reuters.

“Even if the government’s proposed fiscal measures are passed, the debt burden will not decline in the near-term.”

Her comments echo remarks by Moody’s senior analyst Mauro Leos, who told Reuters last month that Brazil will not return to investment grade before the end of Temer’s government in 2018.

In an interview with Reuters last week, a senior analyst with S&P also said that Brazil is still years away from returning to investment grade. (Reporting by Bruno Federowski; Editing by Brad Haynes and Diane Craft)

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