Brazil cut to junk status

Sau Paulo - Brazilian bonds fell to a record and Petroleo Brasileiro SA tumbled in Germany after Standard & Poor’s knocked the nation’s credit rating to junk, deepening outflows from this year’s worst-performing major emerging market.

The cut to BB+ by S&P, which carried a negative outlook, sent yields on Brazil’s $4.3 billion ofbonds due January 2025 up 34 basis points to 5.87 percent by 12:41 pm in London, the most since the notes were sold two years ago. American depositary receipts of Petrobras lost as much as 8.1 percent in Frankfurt. GAM UK and NN Investment Partners said the real may drop past 4 per dollar, 5.5 percent weaker than Wednesday’s close.

The downgrade makes S&P the first rating agency to bring Brazil back into speculative territory after seven years as investment grade. The move is a reflection of the country’s worsening outlook as President Dilma Rousseff grapples with above-target inflation, the highest interest rates since 2006, a corruption scandal involving state-run Petrobras and the deepest recession in a quarter century.

“This is only the beginning of a very difficult few years for Brazil,” said Per Hammarlund, the chief emerging-markets strategist at SEB AB in Stockholm, who expects the real to weaken at least 2 percent on Thursday. Should Moody’s Investors Service follow in the coming months with a downgrade, “it will be carnage,” he said.

Fitch warning

Fitch Ratings, which has Brazil two steps above junk, pointed to risks to its rating at a conference in London this week. Moody’s ranks Brazil at Baa3, its lowest investment grade. S&P’s new score brings Brazil on par with Hungary, Russia, Bulgaria and Indonesia.

The real has tumbled 30 percent in 2015, more than any of the other 23 developing-country currencies tracked by Bloomberg, while the nation’s Eurobonds have handed investors losses of 7.6 percent through yesterday.

The Next Funds Ibovespa Linked Exchange-Traded Fund dropped 4.1 percent in Tokyo on Thursday, while the Lyxor ETF Brazil in Paris fell 7.6 percent, poised for a record low.

“The first reaction will be to sell, but there’s hope that this is the shock the politicians need to take action,” said Paul McNamara, who manages $4.5 billion in assets as investment director at GAM in London, and is market weight on Brazil local debt. The currency, which closed at 3.7801 against the dollar on Wednesday, may weaken past 4 per dollar “sooner rather than later,” he said.

BRICS risk

The downgrade rekindles speculation about the future of Finance Minister Joaquim Levy. His mandate has been to shore up Brazil’s finances and help avert Wednesday’s downgrade and could serve as a wake-up call and reinforce his message that legislators need to act faster.

Rousseff’s popularity, meanwhile, is at an all-time low amid an investigation into corruption that allegedly occurred while she was chairman of the state-run oil company. This has helped spur calls for her impeachment and sparked a wave of nationwide protests.

S&P’s step also raised the specter that other nations in the so-called BRICS grouping, particularly South Africa, could be under threat of downgrades, with Commerzbank saying Africa’s most-industrialized country may be next in line. Russia was already reduced to junk by S&P and Moody’s Investors Service this year. Brazil and South Africa are vulnerable to a slowdown in China because the world’s second-largest economy is their biggest export market.

“BRIC ratings action is probably the biggest risk for emerging markets as a whole rather,” Simon Quijano-Evans, the chief emerging-market strategist at Commerzbank in London, said in an e-mailed note. “Market volatility is set to remain, with the onus now being on China to react with new policy measures,” he said, maintaining “safe-haven recommendations” in central and eastern European fixed income.

BLOOMBERG

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