S&P Cuts Brazil To Junk: What It Means

• S&P cut Brazil's sovereign credit rating to BB+.
• The Bovespa index fell about 0.6 percent on Thursday. The real tumbled more than 1.75 percent.
• Although a downgrade was expected, the timing of the demotion was unexpected.

Standard & Poor's has downgraded Brazil’s sovereign credit rating to BB+. While the move came as no surprise, the timing did catch many analysts and investors off guard, as the demotion was expected for later this year.

In addition, the firm maintained the outlook on the rating at negative. This also surprised most analysts.

Analyst Views

In a report issued Thursday, HSBC analysts Alejandro Martinez-Cruz and Constantin Jancsó assured, “The negative outlook reflects that further fiscal deterioration is not being ruled out and this may trigger additional rating actions over a 12-month period.”

Capital Economics’ Edward Glossop added, “Brazilian markets may come under some pressure over the coming days and weeks following the decision.” However, the firm suspects that a considerable portion of the impact of the demotion has “already been priced in."

In the experts’ view, “perhaps the greater concern is that the downgrade will add fuel to the speculation that Finance Minister Levy –one of Brazil’s only policymakers with any credibility in the markets and the key driver of the country’s austerity efforts –could leave his post.”

According to S&P, the recent 2016 budget proposal suggests the market will witness a third consecutive year of primary deficit and surging government debt. This, most analysts speculate, was the main driver behind the firm’s downgrade.

“The decision was mostly priced in credit spreads, but we expect further deterioration in the short term as the timing was unexpected and with increasing concern that benchmarked investors could be forced to sell if a second rating agency cuts Brazil to junk. The earlier-than-expected move is supportive to our 1s/2s CDS flattener position,” the HSBC note added.

Moody’s recently said it thinks Brazil has some credit strengths relative to other countries with Baa ratings.

Shares of the iShares MSCI Brazil Index (ETF) (NYSE: EWZ) fell almost 2 percent on Thursday trading.

Shares of the Market Vectors Brazil Small Cap ETF (NYSE: BRF) lost almost 3.5 percent.