Inflation forecasts in Brazil are declining from a two-year high after policy makers signaled they are ready to raise borrowing costs to curb consumer prices, bond yields show.
The yield gap between the government’s inflation-linked and fixed-rate bonds due in 2013 shrank 25 basis points, or 0.25 percentage point, yesterday to 612 after the central bank said there’s a need for “adjustment” in interest rates to stem consumer price increases. The yield difference, a gauge of investor expectations for annual inflation over the next two years, reached 637 earlier this week, the highest since December 2008, according to data compiled by Bloomberg.
Demand for protection against inflation is waning on speculation Brazil will join countries from Chile to Thailand in raising borrowing costs. Brazilian bonds tied to an index of consumer prices outperformed fixed-rated bonds in each of the past four months amid concern policy makers may fail to act fast enough to contain inflation that quickened to a 23-month high.
“With rate increases, inflation expectations should fall next year,” said Marcelo Schmitt, a fixed-income portfolio manager at SulAmerica Investimentos, which has 18 billion reais ($10.6 billion) under management. The outperformance of inflation-linked bonds may “come to an end,” he said in a telephone interview in Sao Paulo.
Schmitt said he has been selling his inflation-linked bonds and buying fixed-rate debt over the past two weeks.
The yield on notes tied to inflation jumped 18 basis points yesterday, the most since Nov. 29, to 6.33 percent, according to Bloomberg data. The government’s fixed-rate debt rallied, driving up prices and pushing yields down 7 basis points to 12.45 percent.
Annual inflation quickened to 5.79 percent in the 12 months through mid-December, fueled by higher food prices, credit and wage growth. It was the fourth consecutive month consumer prices exceeded the government’s target of 4.5 percent, plus or minus two percentage points.
Policy makers have to “contain the mismatch between the pace of expansion of domestic demand and the production capacity of the economy,” according to the central bank’s quarterly inflation report released yesterday.
Interest-rate increases of 150 basis points to 12.25 percent and a stable currency would bring down inflation to around the 4.5 percent target in the next two years, Carlos Hamilton, central bank director for economic policy, told reporters in Brasilia yesterday. The real is up 40 percent against the dollar in the past two years.
The inflation report sends “a very strong signal” that the central bank will “start the hiking cycle in January,” Marcelo Salomon, chief Brazil economist for Barclays Plc in New York, said in a telephone interview. The risk of inflation “overshooting” the upper ceiling of the central bank’s target has declined as policy makers sent a “clear message” that they will act quickly, he said.
Barclays yesterday moved its forecast for a rate increase to January from March, predicting the central bank will raise borrowing costs 150 basis points by the end of April.
Alexandre Tombini, who was confirmed as central bank president by the senate last week, will increase lending rates by 50 basis points when he chairs his first monetary policy meeting Jan. 18-19 and push it up to about 12.75 percent by the end of 2011, interest-rate futures contracts show. Brazil’s 10.75 percent rate compares with U.S. borrowing costs of between zero and 0.25 percent.
The extra yield investors demand to hold Brazilian dollar bonds instead of U.S. Treasuries narrowed 2 basis points to 179 at 3:54 p.m. New York time, according to JPMorgan Chase & Co.
The cost of protecting Brazilian debt against non-payment for five years with credit-default swaps fell 1 basis point yesterday to 113, according to data compiled by CMA. 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.
The real rose 0.5 percent to 1.6913 per dollar.
Brazilian inflation-linked bonds maturing in less than five years returned 12.7 percent this year, compared with an 11.2 percent advance for fixed-rated securities, according to data compiled by the country’s capital markets association.
Debt tied to consumer prices in the U.S. gained 8.1 percent this year, while similar securities in Turkey returned 24 percent, Bank of America Merrill Lynch data show.
Brazil’s inflation-linked bonds “may lose part of the appeal they had so far,” said Barclays’ Salomon.