Brazil's real fell to a record low and stocks posted their biggest drop since early 2023 as the country's proposal to cut public spending by about $12 billion disappointed investors who are increasingly concerned about Brazil's budget deficit.
The currency fell 1.5% to 6.02 against the dollar on Thursday. Swap rates surged more than 40 points and the country's benchmark stock index fell 2.4%.
Finance Minister Fernando Haddad unveiled a long-awaited plan to cut public spending by 70 billion reais by 2026. The measures include limiting minimum wage increases, capping high salaries for public employees and imposing higher taxes on those earning more than 50,000 reais a month.
“We are seeing increased uncertainty and heightened risk perception in Brazilian assets,” said Patricia Urbano, a fund manager at Edmond de Rothschild. “Local assets have been sold off over the past two days and could fall further given the level of uncertainty.”
The real continued to fall in late trading on Thursday after President Lula doubled down on his fiscal plan. Haddad said his team would propose more measures to control spending in the future if necessary, while Lula said he wanted the cabinet to focus on completing measures already proposed rather than developing new proposals.
Brazilian assets have been hammered by growing pessimism about the outlook for Brazil’s growing budget deficit. Lula has been increasing spending since taking office in 2023 to deliver on a promise to improve living standards for Brazil’s poor. This year, coffers have come under further pressure as the government coped with historic floods, widespread forest fires and a record drought.
The plan was originally scheduled to be announced earlier this month but was delayed as Lula pushed to include a measure to exempt monthly wages of up to 5,000 reais from income tax. The move added to pessimism as traders believed it would weaken the fiscal impact of the package.
“The government has made minimal proposals to maintain the fiscal framework, but this is not enough to reverse the perception that the country’s fiscal situation is deteriorating,” said Luis Cezario, chief economist at Asset1 Investimentos. “The fiscal package appears to be too little too late.”
Growing distrust in the government’s fiscal commitments has hit inflation expectations, prompting Brazil’s central bank to raise interest rates just as the Federal Reserve is easing monetary policy.
Market pricing shows traders betting Brazil’s benchmark rate will rise to close to 15% by the end of next year from 11.25% now. JPMorgan now predicts it will reach 14.25% by the end of the tightening cycle, up from its previous forecast of 13%.
“The risk of a fiscal downturn in 2026 and beyond is greater than we expect, which could further stimulate demand in an already overheated economy,” Cassiana Fernandez, head of Latin America economic research at JPMorgan, wrote in the report. “Monetary policy needs to act more decisively to offset these fiscal effects and the risks of their imbalances.”
Brazil’s market fell as emerging currencies broadly slumped following the election of Donald Trump as U.S. president. Trump’s policies will strengthen the dollar and stoke inflation in the world’s largest economy, forcing central banks around the world to raise interest rates and curb growth.
But even amid the gloom for emerging-market assets, Brazil’s losses stand out. The currency has fallen more than 19% this year, the most among major currencies. The Ibovespa stock index is down more than 7% this year, lagging emerging-market stocks and most global benchmarks.
JPMorgan Chase & Co. and Morgan Stanley have both downgraded Brazilian stocks in the past few weeks, citing the prospect of a growing budget deficit and rising interest rates.
“The government spent the last month building expectations that it would come up with spending cuts, but when the big day came, we saw fiscal stimulus instead,” said Pedro Dreux, currency manager at Occam Brasil Gestao in Rio de Janeiro. “The result is a deterioration in assets, reflecting the government’s tendency to overspend.”
Article forwarded from: Jinshi Data