New York: Brazil's real plummeted to an all-time low on Wednesday, experiencing its steepest drop in over two years, as financial markets began questioning the Brazilian government's fiscal strategy and mounting budget deficit. The local currency slid to a record 6.3139 per dollar before closing 2.9% lower at 6.2896, marking its largest daily drop since November 2022. Earlier in the session, the real had closed at 6.26, a 2.7% decline.

The currency’s decline was further compounded by the U.S. Federal Reserve's decision to lower interest rates while signaling a slower pace of cuts, which boosted the dollar globally. Meanwhile, Brazil's benchmark Bovespa stock index fell 3.15%, its biggest one-day drop since November 2022, ending at a six-month low. Investors grew increasingly concerned about the nation's financial stability, as the cost of insuring Brazil's sovereign debt hit a 14-month high.

The market turmoil reflects growing investor skepticism about whether Brazilian lawmakers can pass critical fiscal reforms needed to stabilize the country’s finances. "The main concern is the fragile fiscal path, which is affecting inflation expectations and putting pressure on the real," said Thomas Haugaard, portfolio manager at Janus Henderson in Copenhagen. "The market often only reacts with necessary adjustments after turmoil, but for now, there doesn’t appear to be an immediate fiscal response."

The Brazilian Congress approved the main text of a key fiscal bill late on Tuesday, though some amendments are still under debate. Finance Minister Fernando Haddad stated that the Senate is ready to vote once the bill is fully passed by Congress. "We are doing our part, ensuring the measures are not watered down, and convincing people that they are essential to strengthen the fiscal framework," Haddad said.

In response to the turmoil, Brazil’s central bank has been actively intervening, holding spot U.S. dollar auctions for the third consecutive session and maintaining a firm monetary stance. "The central bank has hiked rates more than expected and continues to intervene in the currency market, showing they are doing their part," noted Shamaila Khan, head of fixed income for emerging markets at UBS Asset Management.

The yield on Brazil’s local sovereign bonds surged to 14.77% on Wednesday, with the benchmark hitting a high of 14.847% earlier in the week—the highest level since March 2016. The yield began the year at around 10.5%.

Market experts note that the bar for positive fiscal news is now very low. Arif Joshi, co-head of the emerging markets debt platform at Lazard Asset Management, emphasized that fiscal consolidation needs to go beyond optimistic projections of stronger growth and focus on actual spending cuts. "It's about taking small steps and building from there," Joshi said. "We are not expecting drastic changes, just gradual, positive steps."

Credit default swaps for Brazil's five-year sovereign debt, a gauge of default risk, reached 194 basis points, the highest since October 2023. Meanwhile, the dollar-denominated MSCI Brazil index has fallen over 30% since the start of the year. Brazil’s nominal budget deficit, including interest payments on public debt, has expanded to 9.5% of GDP, up from 4.6% when President Luiz Inácio Lula da Silva took office in January 2023.