Brazilian traders are betting central bank President Henrique Meirelles will end increases in borrowing costs too soon to keep inflation in check.
The difference between yields of the overnight interest rate futures contract due in January 2012 and in 2014 widened to a three-month high 47 basis points, or 0.47 percentage point, today after policy makers said yesterday that economic growth may have slowed to a sustainable level. The gap has grown 16 basis points since July 21, when the central bank raised the rate a less than forecast 50 basis points to 10.75 percent.
Meirelles, 64, is preparing to stop raising lending rates and will be forced to increase them later as inflation, at 4.8 percent, accelerates, the futures market shows. Traders are wagering the central bank will lift the so-called Selic rate no more than a total of 25 basis points in the next three meetings.
“We are getting to the end of the tightening process,” said Marcelo Saddi Castro, who oversees 18 billion reais ($10.2 billion) as chief investment officer at SulAmerica Investimentos in Sao Paulo. “There’s considerable risk that inflation won’t convert to the central bank’s target in the next year and a half. Given the strong uncertainty, the yield curve tends to steepen.”
The central bank targets annual inflation at 4.5 percent. Policy makers said in minutes of their July 20-21 meeting released yesterday that “the economy may have settled into a pace that is more in line with growth levels considered sustainable in the long term.”
Brazil’s economy will continue to have a “weak” expansion in the third quarter and probably contracted 0.1 percent in July, Valor Economico reported today, citing Economic Policy Secretary Nelson Barbosa.
Economists forecast the annual inflation rate will quicken to 5.35 percent by yearend before slowing to 4.8 percent by the end of 2011, according to a central bank survey published this week. Annual inflation declined to a four-month low of 4.8 percent in June, while retail sales and industrial production missed forecast in May.
Yields on contracts due in January fell to a three-month low of 10.77 percent today, suggesting traders are betting that policy makers will either lift the Selic rate by a total of 25 basis points for the remaining three meetings this year or keep it unchanged. Traders predicted in September that the rate would rise to 12.5 percent by year end, according to data compiled by Bloomberg.
“The central bank works to reach the midpoint of the inflation target and doesn’t comment on market analysis,” the bank said in an e-mailed statement yesterday.
The country’s monetary council set an inflation target of 4.5 percent for 2010, allowing a range of 2 percentage points above or below that midpoint. Consumer prices, while falling, have remained above 4.5 percent every month this year.
Meirelles has increased the Selic rate 200 basis points this year, from a record low of 8.75 percent. Brazil’s economic expansion will slow from the 9 percent pace in the first quarter after the government withdrew tax breaks and cut spending, and the central bank began rate rises in April, Finance Minister Guido Mantega said in an interview last week.
“The committee sees an improving inflation outlook,” wrote Mauricio Oreng and Ilan Goldfajn, economists at Itau Unibanco Holding SA, Latin America’s biggest bank by market value, in a research note to clients yesterday. “However, our medium-term outlook points to further rate increases afterwards. We believe the reappearance of inflation risks will prompt the central bank to move back to tightening mode in January 2011.”
Credit Suisse AG of Zurich recommends that clients bet yields on long-term contracts will fall since the central bank will likely succeed in cooling inflation and attracting foreign investors, said Igor Arsenin, a strategist in New York, in an interview yesterday.
“Brazilian rates are very high by international standards,” said Arsenin. “For someone with a long-date horizon, in all likelihood Brazil rates will normalize to global averages, providing long term capital gains.”
Elsewhere in Brazil’s credit markets, the government yesterday sold 1.73 billion reais of notes due in 2014, with average yields of 12.22 percent. It also sold 583.2 million reais of bonds maturing 2021, drawing an average yield of 12.18 percent.
The Treasury said yesterday that it plans to sell as much as 40 billion reais of domestic bonds in August. Brazil has 37.3 billion reais of bonds due to mature next month, according to a posting on its website yesterday.
The extra yield investors demand to hold Brazilian dollar bonds instead of U.S. securities narrowed 44 basis points this month to 204, the biggest decline since May 2009, according to JPMorgan Chase & Co. The real gained 2.5 percent to 1.761 per dollar, reducing its decline this year to 0.9 percent.
The cost of protecting Brazilian debt against non-payment for five years with credit-default swaps fell 21 basis points this month to 116, the biggest decline in a year, according to data compiled by CMA DataVision. Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a government or company fail to adhere to its debt agreements.
Economists forecast the Selic will jump to 11.75 by year end, a central bank survey of 100 analysts published this week shows. The economy will expand this year by 7.2 percent, the fastest pace in more than two decades, the survey shows.
“Our general view is that growth is quite solid,” Rogerio Oliveira, a strategist at Morgan Stanley in New York who expects the yield on the 2014 contract to rise to 12.5 percent in coming months, said in an telephone interview yesterday. “They will have to restart tightening early next year. That helps the perception that the curve should be steeper.”