Implications of S&P’s outlook change on Brazil assets

The S&P recent change in the Brazil's sovereign rating (BBB-) outlook to negative is expected to effect rating trajectory and further heightened volatility from a sovereign credit, corporate credit, and local markets perspective.

"We believe that only a change in the relationship between the government and Congress can avoid a downgrade over the next year," noted Barclays Research.

For Brazil HC bonds, the loss of IG status (ie, two rating agencies moving to HY) would lead to exclusion from Global IG bond indices, such as the Barclays Global Agg index family. At current spread levels, and judging by yesterday's price action, the market is already positioned for a rather negative trajectory, concerns about IG index exclusion effects could lead to heightened volatility and cap potential upside for Brazilian credit at this stage. 

On the FX/local markets side, any index effects should be limited, due to the BRL not being an eligible currency for the Global Agg index anyway. Although dedicated EM investors are likely to be largely insensitive to ratings, negative sentiment effects still argue for an even weaker currency, likely testing the BCB tolerance for higher inflation.