Market commentary: Brazil credit rating falling fast

Brazil made the headlines again yesterday after the sovereign’s Baa3 rating from Moody’s was put on review for downgrade, moving it one step closer to junk. Brazil’s 10y yield jumped about 8bps after the news although analysts and traders alike suggested it wasn’t a great surprise given S&P already has the sovereign at BB+.

The pace at which Brazil looks set to lose investment grade status from at least two agencies, is happening a lot quicker than most investors expected.

Shortly following the news Moody’s also announced that it had cut Petrobras’ rating deeper into junk at Ba3 (from Ba2), while also warning that the rating could be lowered further. All this adding to the woes for a company which is very much in focus at the moment given the current corruption investigations.

In terms of what a Brazil downgrade to junk means for other Brazilian names, we expect about $12bn of senior bank bonds to be at risk of forced selling giving the potential for a number of banks to lose investment grade status. It should be highlighted that a potential loss of IG status has been well flagged in the market and so positioning is likely already reflecting this to some extent.

Looking at the latest in Asia this morning, it was a mixed start across equity markets in the region. Gains were seen out of China where the Shanghai Comp (+0.40%) and CSI 300 (+0.64%) are both up modestly. The Nikkei (-1.23%) appears to be following more of the lead from the US last night, while the ASX (-0.84%) has fallen steeply despite some strong employment data out of Australia this morning, instead reflecting perhaps the reduced risk of any more near term cuts from the RBA.

The Aussie Dollar is up 1% post the data. Meanwhile the NZD has pared back a little but was up a similar amount despite a cut from the RBNZ late last night, lowering the cash rate by 25bps to 2.5%. The currency stronger on the expectation that the move may also mark the end of the current easing cycle.

Elsewhere this morning, Oil markets have rebounded nearly 1% in early trading, which has helped US equity futures to edge higher. WTI Crude is currently trading at USD 37.43 as of this writing, trading close to recent lows.

One of the main concerns of the continued oil price plunge is the effect on the US high yield market which is dominated by American energy producing companies which are under severe pressure. As companies in the sector see the value of their assets wane, expect bondholders to be forced to take some losses as the capital structure of the companies becomes more unsustainable.

The current main concern is that should the bubble burst, this will have a contagion affect across all high yield bonds in the US, widening spreads across the board.

In early trading in Europe this morning, the DAX is marginally down (-0.18%) along with all other European bourses, with the Euro Stoxx 50 down 0.35%. European Treasury yields are down, with the German 10 year trading at 0.589% yield, while Italy and Spain are trading at 1.559% and 1.615% respectively.

This article was issued by Simon Psaila, Treasury Officer Investment Manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt . The information, view and opinions provided in this article is being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice. Calamatta Cuschieri & Co. Ltd has not verified and consequently neither warrants the accuracy nor the veracity of any information, views or opinions appearing on this website.