In September, Standard & Poor’s downgraded Brazil’s sovereign debt to junk status. On Thursday, Fitch changed its credit rating of Brazil from BBB to BBB-, just one notch above junk status. What does it mean for the global economy and the gold market?

Fitch downgraded its credit rating of Brazil due to the “rising government debt burden, increased challenges to fiscal consolidation and a worsening economic growth backdrop”. Even more importantly, Fitch’s outlook for Brazil remained negative (this means that there is a 50 percent chance of a downgrade to the country’s rating in the next few years). The agency forecasts that the general government deficit will deteriorate to about 9 percent of GDP in 2015, while GDP will contract by 3 percent and 1 percent, respectively, in 2015 and 2016. Further deterioration of the credit rating will led to capital outflows from Brazil, since a lot of pension funds have rules that force them to pull money out of countries with junk status given by two main credit agencies. So far, Brazilian debt has been branded “junk” only by Standard & Poor’s, while Fitch and Moody’s Investors Service still assign an investment-grade score to the country’s sovereign debt.

Brazil’s economic problems result from a slowdown in global (especially in Chinese) economic growth, decline in commodity prices, unsound fiscal and monetary policies, corruption, political uncertainty, and expectations of a Fed hike. They are part of the worldwide financial turmoil in emerging markets. In fact, the BRIC nations in particular have lost their luster recently. Does anyone remember that these countries were supposed to dominate the global economy and dethrone the U.S. dollar?

The impact of Brazil’s economic woes could be a significant drag on Latin America as a whole, because Brazil is the main trading partner for many countries in the region. The impact on the U.S. economy should be limited, however, Brazil was the 7th largest goods export market for the U.S. in 2013. And how the gold market will be affected depends largely on the greenback’s performance. If investors believe that Uncle Sam is decoupling from the global slowdown, any potential rises in the price of gold would be limited by a downward pressure from the U.S. dollar. However, if investors drop the decoupling story and dampen expectations of a Fed hike – and this is precisely what we are witnessing right now – the emerging market crisis may add fuel to the recent increases in the gold market.

The take-home message is that Brazil is just one step away from receiving junk status from two main rating agencies. When that happens – and that is going to happen – there will be capital outflows from Brazil. It may strengthen the U.S. dollar, but the greenback is depreciating right now, so gold could emerge as the biggest winner from the recent turmoil in Brazil and other emerging markets.

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Arkadiusz Sieron
Sunshine Profits‘ Gold News Monitor and Market Overview Editor

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