Top Brazil investors shun local assets as recession threat looms

Bloomberg

Brazil’s largest independent hedge funds have grown wary of local assets after the nation moved to ease its fiscal rules, fuelling fears of a sharp increase in interest rates and a potential recession ahead.
Firms including Itau Unibanco now predict Brazil’s economy will contract next year after policy makers raise the benchmark rate to over 11%, the highest since 2017. That could crimp an economy already struggling in the wake of the global pandemic, which hit Brazil hard. But analysts say it will be needed to keep a lid on inflation as President Jair Bolsonaro pushes to boost public expenditure ahead of elections set for next year.
While Brazilian assets extended their slump last month, funds managed by Ibiuna Investimentos and Legacy Capital maintained their bets on higher oil prices and Kapitalo Investimentos boosted long positions in the commodity. West Texas Intermediate crude oil has surged about 70% this year.
Brazilians continued to yank money out of domestic hedge funds last month. The Ibovespa stock index fell 6.7%, its fourth straight monthly loss. Local government bonds dropped 3.4%, the worst performance in data going back to 2008. Among funds, Adam Capital posted its best performance in over three years, while Verde Asset Management’s attempt to buy the dip in local stocks backfired — and its flagship posted one of its worst months since its 1997 inception.
High inflation, lack of clarity over the government’s new social program and Bolsonaro’s threat to interfere in Petrobras’s fuel prices helped drive the weak performance of local stocks last month. Adam’s funds have positions that stand to benefit from the strength of the US economy.
Brazil’s key rate may reach 14% as policy makers try to re-anchor inflation expectations. The country lost its main pillar of fiscal balance by compromising the spending cap. Hedge funds managed by Bahia continued to cut exposure to Brazilian stocks last month. Scenario demands above-normal caution.
Repricing of Brazil risk continues and the asset manager stuck to its cautious stance on local assets. Fund is betting the dollar will gain against the real. Fears of a potential populist shift in Brazil’s economic policy have materialised. Ibiuna maintained its long position in oil prices.
Brazil’s debt dynamics have worsened as the government eased fiscal rules, with high inflation and heightened fiscal risks making BCB’s task harder. Policy makers will have to lift interest rates far beyond what the market expected, which should weigh on economic activity. Fund scrapped its paying position in local rates and boosted its long position in oil.