After showing some signs of life in recent weeks, exchange traded funds tracking Brazilian debt and equities could be put to the test after Standard & Poor’s Tuesday lowered the country’s sovereign debt rating to BBB-, the lowest investment grade.
“Mixed policy signalling by the government, with negative implications for fiscal accounts and economic policy credibility, coupled with a subdued outlook for growth over the next two years continue to weigh on Brazil’s policy flexibility and performance profile,” said the ratings agency, according to Reuters.
The news broke Monday evening after the close of U.S. market s and after the iShares MSCI Brazil Capped ETF (NYSEArca: EWZ) closed higher by 1.2%. Since the start of February, EWZ is up nearly 11% while the Market Vectors Brazil Small-Cap ETF (NYSEArca: BRF) is higher by 5.5%.
S&P did raise its outlook on Brazilian debt to stable from negative, which implies further downgrades from the ratings agency are unlikely in the near-term. That should come as some relief to the actively managed WisdomTree Emerging Markets Local Debt Fund (NYSEArca: ELD) and the passively managed Market Vectors Emerging Markets Local Currency Bond ETF (NYSEArca: EMLC), both of which allocate about 10% of their weights to Brazilian bonds. [Considering Brazilian Bond ETFs]
However, the S&P downgrade could prompt other ratings agencies to follow suit. In October 2013, Moody’s Investors Service pared its outlook on Brazilian sovereign bonds to stable from positive while affirming the credit rating of Latin America’s largest economy at Baa2. [Brazil Bonds Vulnerable After Moody’s Changes]
S&P’s downgrade is seen as potentially problematic for President Dilma Rousseff as she seeks reelection later this year. Although Rousseff is popular in her native country despite its battles with inflation and some of the highest interest rates in the emerging world, financial markets could be signaling regime change would be a positive catalyst for Brazilian markets.
While Brazil ETFs have firmed in recent weeks, those funds still lag India and Indonesia ETFs by wide margins. Investors have bid India and Indonesia ETFs higher this year in anticipation of elections later this year that will deliver pro-market candidates to office. [Indonesia ETFs Soar Ahead of Election]
WisdomTree Emerging Markets Local Debt Fund
ETF Trends editorial team contributed to this post.