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Brazil’s borrowing binge gives investors the jitters



It’s not unusual to hear an emerging market government be told to produce a credible plan showing public finances are sustainable. But when the person demanding it is the government-appointed head of the central bank, there may be greater reason for investor concern.

Paolo Guedes, Brazil’s economy minister, certainly didn’t appreciate the wake-up call late last month, swiftly challenging the central bank chief Roberto Campos Neto: “If he has a better plan, then ask him what his plan is.”

Mr Campos Neto, however, had a point. Mr Guedes is an acolyte of the free market principles of Milton Friedman and a believer in smaller government. But he has gone on one of the emerging market world’s biggest coronavirus-related spending sprees, using a metaphorical credit card which was already maxed out before the pandemic. The extra spending has helped Brazil avoid a deep recession this year, but at what price?

“I’m seriously concerned about the medium-term and the short-term fiscal picture,” says Alberto Ramos, Latin America chief economist at Goldman Sachs. He notes that Brazil has one of the highest levels of public debt to gross domestic product of any emerging market, predicting it will hit 94 per cent this year.

More than 90 per cent of Brazil’s government debt is issued in local currency according to National Treasury figures and the stress is starting to show in domestic markets.

The yield curve for Brazilian debt has steepened sharply this year with the 10-year bond now yielding 7.4 per cent compared with today’s central bank benchmark Selic rate of 2 per cent.

Luis Oganes, global head of emerging markets at JPMorgan, says it is “among the steepest yield curves on the planet” with long-term rates rising sharply from shorter-term ones. Investors are pricing in a rate rise of up to 300 bps starting in January, he adds, and “the government is issuing massively at the short end because it doesn’t want to validate this curve”.

Average maturities on domestic federal public debt are down to 3.57 years at the end of October from 3.83 years at the end of last year, according to Brazil’s national treasury. 

Behind the jitters lies the fear that Brazil’s much-vaunted reform programme to cut high budget deficits — the main reason why investors feted Jair Bolsonaro’s election as president — has stalled.

 “The problem is essentially political,” says Zeina Latif, an economic consultant in São Paulo. “The economy ministry knows what needs to be done but we are seeing an economy minister who has been greatly weakened and who now doesn’t convince.”

Mr Bolsonaro, meanwhile, has discovered the electoral joys of welfare spending. His opinion poll ratings jumped after he launched a $110 a monthly subsidy for nearly a third of the population, at a cost of more than $9bn a month.

Line chart of Yield curve on government debt (7 Dec, %) showing Brazil's borrowing costs

The snag is that the “coronavoucher” payments are due to end on December 31. As his re-election campaign cranks up, Mr Bolsonaro may find the attractions of literally buying popularity impossible to resist — particularly after his candidates fared poorly in November’s municipal elections.

Marcelo Castro, a portfolio manager at Brazilian hedge fund SPX Capital, believes a slow deterioration in Brazil is more likely than a sudden crisis. “It’s bubbling and frothing but not exploding,” he says.

Mr Castro expects a rebound in growth next year to drive higher inflation, forcing rates up to 4 per cent by June. But he concedes “there are lots of risk scenarios around this”.

Ilan Goldfajn, chairman of Credit Suisse Brazil and a former central bank head, believes nothing will happen on extending coronavirus spending or progressing reforms until February. “If that’s the case, Brazil can surf the risks for a couple of months,” he says.

However, if next year brought extra spending without reforms, Mr Goldfajn says the risk of a market crisis would increase.

Marcos Casarín, Latin America chief economist at Oxford Economics, agrees the real test will come next year, with short-term debt equal to around 6 per cent of GDP needing to be rolled over by April. “Brazil is on a tightrope,” he says.

The scenario of a markets crisis in Latin America’s biggest economy is not one many Brazil-watchers want to contemplate. But Mr Casarin believes: “It’s increasingly likely that it will become the baseline scenario unless we see a U-turn from Bolsonaro.”

However, Mr Guedes ridiculed the idea that his plans lack credibility in his riposte to the central bank governor, saying: “The day that the stock market is falling 50 per cent and the dollar exploding, then I will say that credibility is lacking.”


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Copper hits record high with demand expected to rise sharply




Copper prices hit a record high on Friday in the latest leg of a broad rally across commodity markets sparked by the reopening of major economies and booming demand for minerals needed for the green energy transition.

Copper, used in everything from electric vehicles to washing machines, rose as much as 1.2 per cent to $10,232 a tonne, surpassing its previous peak set in 2011 at the height of a previous commodities boom.

The price has more than doubled from its pandemic lows in March last year due to voracious demand from China, the biggest consumer of the metal, and also investors looking to bet on a big uptick in the global economy and protect their portfolios against potential for rising inflation.

Government stimulus packages and the shift towards electrification to meet the goals of the Paris agreement on climate change are expected to fuel further demand for the metal, which analysts and industry executives believe could hit $15,000 a tonne by 2025.

“Capacity utilisation rates of our customers are the highest in a decade and that’s before stimulus money both in Europe and the US has started to flow,” said Kostas Bintas, head of copper trading at Trafigura, one of the world’s biggest independent commodity traders. “That will be significant.”

The US and Europe were becoming significant factors in the consumption of copper for the first time in decades, he added. “Before, it’s effectively been a China-only story. That is changing fast.”

Concerns about the long-term supply of copper due to lack of investment by large miners has also pushed up prices. There are only a few large projects in a development, while most of the world’s easily produced copper has already been mined.

“The current pipeline of projects likely to start producing in the next few years represents only 2.3 per cent of forecast mine supply,” said Daniel Haynes, analyst at banking group ANZ. “This is well down on previous cycles, including 2010-13 when it reached 12 per cent.”

The upward march of other raw materials is showing no signs of abating. Steelmaking ingredient iron ore traded above $200 a tonne for the first time as China returned to work after the Labour Day holidays in early May. 

In spite of production cuts in Tangshan and Handan, two key steelmaking cities in China, analysts expect output to remain solid over the next couple of quarters. 

“Recent production cuts in Tangshan have boosted demand for higher-quality ore and prompted mills to build iron ore inventories as their margins are on the rise with steel supply being restricted,” said Erik Hedborg, a principal analyst at CRU Group.

“Iron ore producers are enjoying exceptionally high margins as around two-thirds of seaborne supply only require prices of $50 a tonne to break even.”

Elsewhere, tin on Thursday rose above $30,000 a tonne for the first time in a decade before easing. Tin is used to make solder — the substance that binds circuit boards and wiring — and is benefiting from strong demand from the electronics industry, which has been lifted by growing numbers of stay-at-home workers.

US wood prices continued to race higher ahead of the peak in the US homebuilding season in the summer with lumber futures rising to a record high above $1,600 per 1,000 board feet length, up from $330 this time last year.

Agricultural commodities also continued to rally as a result of a particularly dry season in Brazil, concerns about drought in the US and Chinese demand. Strong increases in food prices have started to affect global consumers. Corn rose to a more than eight-year high of $7.68 this week, while coffee has risen almost 10 per cent since the start of month, hitting a four-year high of $1.54 a pound this week.

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Wall Street stocks waver as investors await US jobs data




Wall Street stock markets wavered, with tech losses dragging down some indices, but remained close to record highs ahead of US jobs data on Friday that could pile pressure on the Federal Reserve to rethink its ultra-supportive monetary policies.

The S&P 500 was up 0.2 per cent in the afternoon in New York, hovering slightly below its all-time high achieved late last month. The peak was reached following a long rally supported by the Fed and other central banks unleashing trillions of dollars into financial markets in pandemic emergency spending programmes.

The technology-heavy Nasdaq Composite, however, which is stacked with growth companies sensitive to changing interest rate expectations, was down 0.5 per cent by the afternoon in New York, the fifth straight losing session for the index.

The divergence of the two indices followed patterns from earlier this year, when investors sold out of growth companies over fears of rising rates and poured into more cyclical plays. That trade has been more muted recently but could be coming back, said Nick Frelinghuysen, a portfolio manager at Chilton Trust.

“It’s been a bit more ambiguous . . . in terms of what regime is leading this market higher, is it quality and growth or is it value and cyclicals?” Frelinghuysen said. “We’re in a little bit of a wait-and-see mode right now.”

The 10-year Treasury yield, which rose rapidly earlier this year amid inflation fears, declined 0.05 percentage points to 1.56 per cent on Thursday.

In Europe, the Stoxx 600 closed down 0.2 per cent, hovering just below its record high reached in mid-April.

With the US economy close to recovering losses incurred during coronavirus shutdowns, economists expect the US government to report on Friday that the nation’s employers created 1m new jobs in April. Investors will scrutinise the non-farm payrolls report for clues about possible next moves by the Fed, which has said it will continue with its $120bn a month of bond purchases until the labour market recovers.

Up to 1.5m jobs would “not be enough for the Fed to shift”, analysts at Standard Chartered said. “Between 1.5m and 2m, there is likely to be uncertainty on Fed perceptions.”

Central bankers worldwide had a strong “communications challenge” around the eventual withdrawal of emergency monetary support measures, said Roger Lee, head of UK equity strategy at Investec.

“If it is orderly, then you can expect a gentle continuation of this year’s stock market rotation” from lockdown beneficiaries such as technology shares into economically sensitive businesses such as oil producers and banks, Lee said. “If it is disorderly, it will be a case of ‘sell what you can’.”

On Thursday the Bank of England upgraded its growth forecasts for the UK economy but stopped short of following Canada in scaling back its asset purchases.

The BoE maintained the size of its quantitative easing programme at £895bn, while also keeping its main interest rate on hold at a record low of 0.1 per cent. The British central bank added that while its asset purchases “could now be slowed somewhat” after it became the dominant buyer of UK government debt last year, “this operational decision should not be interpreted as a change in the stance of monetary policy”.

Sterling slipped 0.1 per cent against the dollar to $1.389.

The dollar, as measured against a basket of trading partners’ currencies, weakened 0.4 per cent. The euro gained 0.4 per cent to $1.206.

Brent crude fell 1.1 per cent to $68.17 a barrel.

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Gensler raises concern about market influence of Citadel Securities




Gary Gensler, new chair of the Securities and Exchange Commission, has expressed concern about the prominent role Citadel Securities and other big trading firms are playing in US equity markets, warning that “healthy competition” could be at risk.

In testimony released ahead of his appearance before the House financial services committee on Thursday, Gensler said he had directed his staff to look into whether policies were needed to deal with the small number of market makers that are taking a growing share of retail trading volume.

“One firm, Citadel Securities, has publicly stated that it executes about 47 per cent of all retail volume. In January, two firms executed more volume than all but one exchange, Nasdaq,” Gensler said.

“History and economics tell us that when markets are concentrated, those firms with the greatest market share tend to have the ability to profit from that concentration,” he said. “Market concentration can also lead to fragility, deter healthy competition, and limit innovation.”

Gensler is scheduled to appear at the third hearing into the explosive trading in GameStop and other so-called meme stocks in January.

Trading volumes in the US surged that month as retail investors flocked into markets, prompting brokers such as Robinhood to introduce trading restrictions that angered investors and drew the attention of lawmakers.

The market activity galvanised policymakers in Washington and investors. Lawmakers have focused much of their attention on “payment for order flow”, in which brokers such as Robinhood are paid to route orders to market makers like Citadel Securities and Virtu.

That practice has been a boon for brokers. It generated nearly $1bn for Robinhood, Charles Schwab and ETrade in the first quarter, according to Piper Sandler.

Gensler noted that other countries, including the UK and Canada, do not allow payment for order flow.

“Higher volumes of trades generate more payments for order flow,” he said. “This brings to mind a number of questions: do broker-dealers have inherent conflicts of interest? If so, are customers getting best execution in the context of that conflict?”

Gensler also said he had directed his staff to consider recommendations for greater disclosure on total return swaps, the derivatives used by the family office Archegos. The vehicle, run by the trader Bill Hwang, collapsed in March after several concentrated bets moved against the group, and banks have sustained more than $10bn of losses as a result.

Market watchdogs have expressed concerns that regulators had little or no view of the huge trades being made by Archegos.

“Whenever there are major market events, it’s a good idea to consider what risks they might have placed on the entire financial system, even when the system holds,” Gensler said.

“Issues of concentration, whether among market makers or brokers at the clearinghouse, may increase potential system-wide risks, should any single incumbent with significant size or market share fail.”

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