UBS’s wealth management area in Brazil adjusted its risk projections to reflect higher interest rates for longer here and in the United States and a scenario of greater volatility ahead. With the U.S. Federal Reserve’s expectations of cuts being dashed, the White House succession, the weakened real, and the perception that Brazil’s policy interest rate will remain at 10.5% per year, investors have no reason to rush to seek value from assets with a greater return potential, such as equity, debt, or long inflation-indexed bonds.
At the macroeconomic level, concerns about the trajectory of Brazilian debt gained emphasis compared to the international scene and led local assets to perform worse than the average of their emerging peers in the first half of the year. The result was a depreciation of the real and Brazilian shares and an increase in future interest rates, both nominal and real.
As a response, UBS reduced the equity portion in its portfolio and increased its interest-rate positions in floating-rate securities to take advantage of double-digit yields. While the foreign exchange rate is fluctuating and there are no clear triggers to reduce the aversion feeling, it is worth taking advantage of fixed income yields.
“Ultimately, what could untangle this knot is the perception of the Brazilian fiscal program going forward,” said Luciano Telo, chief investment officer Brazil at UBS Global Wealth Management, when commenting on the change in allocation, in an interview with Valor. “We understand that the NTN-B [B-series National Treasury Note] paying 6.40% real interest rate [6.5% on Wednesday, 3] is very attractive. We also understand that the stock market is trading at a discount. But there’s no need for doing that now.”
On the stock market, foreign investors sold more than net R$40 billion in shares this year, with Brazil off the radar of foreign capital. Domestic investors have 10.5% of the starting CDI (the interbank deposit rate, used as an investment benchmark in Brazil). So far, UBS’s recommended portfolios were overallocated to Brazilian stocks, considering that, as interest rates fell, investors would take advantage of reduced prices. That’s not what happened.
“I understand that it [stock market] is discounted, but I cannot be much above the historical average if I have a fixed income alternative that is paying well, with lower volatility, if there is no price catalyst [capable of] quickly driving the stock market,” Mr. Telo points out.
Since April, when it became clear that the cuts in U.S. interest rates would be postponed, coming in smaller moves, the decompression in Treasuries rates was not followed suit by assets in Brazil. “The favorable correlation according to which an improvement abroad could improve [the market] here was broken,” Mr. Telo said. “From the second quarter onwards, it is about the domestic situation. The market has done its calculations: there is not enough strength abroad, there are not enough [interest rate] cuts so that, regardless of what happens here, the assets could move,” he said. According to Mr. Telo, an improvement in both international and domestic scenarios would be required to ensure that the debt/GDP trajectory is sustainable.
The Brazilian fiscal issue moved to the center of the discussion and a solution seems to be unclear. The government is yet to announce a spending freeze, which could occur at the end of July or only when the budget review for 2025 advances on the calendar. Mr. Telo believes investors tend to remain wary, avoiding structural risk-taking positions, given the absence of a change in expectations driven by deep spending cuts and compliance with the fiscal target.
UBS also made other moves to reduce its portion in inflation-indexed bonds and its position in real interest rates. Although an increase in the Selic is not in the scenario after the unanimous decision of the Monetary Policy Committee (COPOM) to keep the rate unchanged, carrying CDI-indexed securities seems to be the best choice. “That reduces volatility and offers a good return,” Mr. Telo said. “In the case of inflation-indexed bonds, there are built-in interest rate increases until the year-end, which I think is less likely at this point. There is no need to increase it. We have to wait and make sure there will be no bad news.”
The foreign exchange rate is a concern, with the real placed among the most depreciated currencies this year among emerging or developed peers. “The fixed income premium is there, as economic agents have no confidence while the exchange rate continues to depreciate. The hypothesis of having to re-anchor expectations with [higher] interest rates remains in the scenario.”
The executive points out that given the level of foreign exchange reserves and the good shape of external accounts, the real could have the potential to appreciate. However, local uncertainties have made high interest rates insufficient to curb foreign exchange.
In strategies linked to real interest rates, the UBS executive says there is value to capture and NTN-B is historically a good asset. “What is the question? The same thing that happened with the exchange rate is happening with the NTN-B, with inflation-related assets, which continue to increase rates. Every day there is a harder market [price] update.”
The change in command at the Central Bank at the end of the year, with the end of Roberto Campos Neto’s term, is another source of concern, with President Lula’s open friction with the current monetary policy. “The consensus at the Central Bank was positive, a very important sign of the COPOM’s sensitivity to the uncertainties that concern the market,” Mr. Telo says. “Every central bank in the world has to create a reputation, that’s how it is supposed to be.” The executive points out that the fact that the presidential term in Brazil does not coincide with the exchange in command at the Central Bank is an institutional gain. “The Central Bank provided a unanimous guidance of a 10.5% rate until the end of the year, so the market has a reference on how it should operate.”
The last months of 2024 coincide with the presidential election in the U.S. If Donald Trump wins the race there could be changes to immigration policy and import tariffs. These are elements that can pressure inflation in the U.S., leading to high interest rates for longer. That is a combination that could favor a strong dollar, which is not good for emerging markets.
UBS’s portfolio in reais has a structural position on the global stock exchange, although it is slightly under-allocated compared to the historical average. With the expected soft landing of the U.S. economy, there are also opportunities in bonds abroad, Mr. Telo points out. “The dollar gained ground this year and there is an opportunity for further increases in these global positions,” he said, despite a rise in the Treasuries nominal rates due to the election. “There could be some concern later this year but in the medium to long term we see the yields of U.S. corporate and sovereign bonds falling.”
Translation: Liliana Hage
