(Bloomberg) -- Brazilian markets wrapped up a turbulent week after a much vaunted plan to cut government spending came in well short of expectations, adding to angst over the country’s budget.
The package, detailed by Finance Minister Fernando Haddad on Thursday, sent the currency tumbling to an all-time low, and stocks down the most since 2023. Losses extended early Friday as US markets came back from a holiday, with the real dropping as much as 1.7% before rebounding as Haddad, along with Congress leaders, tried to reaffirm their commitment to fiscal constraint.
Even with the bounce, the currency fell 2.8% this week, by far the worst in emerging markets. The nation’s benchmark Ibovespa stock index, which also recouped some losses on Friday, dropped 2.7% on a weekly basis.
“We need to see spending grow within the limits of the fiscal framework,” said André Muller, chief strategist at AZ Quest Investimentos Ltda. “They will have to prove that the framework is sustainable. The main factor that will determine asset prices next year will be the fiscal story.”
Investors have rushed to dump Brazil assets this year amid concern over the nation’s growing debt levels as President Luiz Inacio Lula da Silva increases spending to fulfill pledges of improving living standards for the poor. Data on Friday showed the nation’s nominal budget deficit widened to 74.68 billion reais in October, from 53.8 billion reais the previous month. Economists had projected a deficit of 50.1 billion reais.
‘Throwing in the Towel’
A long-awaited plan unveiled by Haddad to cut 70 billion reais ($11.6 billion) from public spending through 2026 was seen as insufficient to stabilize the growing budget deficit. Lula’s decision to tack on a tax exemption measure for the poor only added to concerns, watering down the package’s savings and signaling a lack of buy-in from the left-wing president to a fiscal adjustment.
“The announcement of the fiscal package was perhaps the government’s last chance to signal that it’s concerned about the debt trajectory,” said Rafael Oliviera, an equity fund manager at Kinea Investimentos. “Local investors are throwing in the towel.”
The growing distrust of the government’s fiscal commitment has hit inflation expectations, pushing the central bank to hike interest rates just as the Federal Reserve eases monetary policy. Swap rates have surged, with markets pricing in a hike of 92 basis points in the benchmark Selic rate in December and another 87 points in January.
“The Brazilian market is very sensitive to negative fiscal headlines and will continue to apply a higher risk premium absent comprehensive structural changes to fiscal expenditures,” said Katrina Butt, a senior economist at AllianceBernstein in New York. “The question now is how the central bank will incorporate this new information.”
Gabriel Galipolo, who’ll take over as central bank governor next year, said late Thursday that the monetary authority is concerned about unanchored inflation expectations and that Brazil may need higher rates for longer. He stuck to that same tone Friday, saying Brazil could lift rates to anchor expectations.
Lula on Friday nominated three new central bank board members, as investors pressure for more aggressive rate hikes to tame inflation. The nominees include Nilton David, the head trader on Banco Bradesco SA’s treasury desk, as director of monetary policy. Brazil’s Senate will have to confirm all of the nominees.
On Thursday JPMorgan projected the Selic will hit 14.25% by the end of the tightening cycle, up from a previous forecast of 13%. Borrowing costs are currently at 11.25%.
The slide in Brazil markets also comes amid a broad drop in emerging assets following Donald Trump’s election in the US in anticipation of higher global rates and a stronger dollar. But the selloff in local assets stands out: the real is down almost 19% this year, the worst performer among major currencies. The Ibovespa stock index has lost more than 6% over the same period, also lagging EM stocks and most global benchmarks.
“The government’s signaling was clear: the political agenda is more important than the fiscal agenda,” said Marcos de Marchi, chief economist at Oriz Partners. “A very big window of opportunity was missed.”
(Updates pricing starting in second paragraph, adds analyst commentary)
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