RBS Suggests Bet on Rising Chile Breakeven Inflation

Investors should bet on Chilean breakeven inflation rising as the central bank moves toward a pause in interest-rate increases, Royal Bank of Scotland Group Plc wrote.

Strategist Siobhan Morden and Sao Paulo-based economist Zeina Latif set a target rate for two-year breakeven inflation of 4 percent in a note to clients. Annual inflation may have accelerated to 2.9 percent in December from 2.5 percent and the central bank may stop raising rates this month or next month, which would probably push breakeven inflation higher, they wrote.

“The risks are to the upside,” Latif said in a phone interview. “We’re unlikely to see decreasing inflation expectations. If the bank slows monetary tightening by pausing or alternating rate hikes, that would reinforce our call.”

Central bank policy makers debated pausing interest rates in November and December, minutes from their meetings show. They decided not to in December partly to avoid surprising the market, according to the minutes published today. Policy makers at the December meeting argued that at the next meetings they would have to decide whether or not to keep rates unchanged.

Breakeven inflation measures the gap between nominal and real interest rates to derive the expected future pace of price increases.

Two-year breakeven inflation in the interest-rate swaps market gained four basis points to 3.58 percent today, according to Bloomberg calculations. RBS first recommended the trade with two-year breakeven at 3.14 percent.

Unemployment in Chile fell to 7.1 percent in the three months through November, and the “tight” job market, as well as rising global food prices and the expanding economy, suggest investors should be asking a higher premium for lending at nominal rates versus inflation-linked, Morden and Latif wrote in the note.

“This is a trade we have had for a couple of months, but it’s my favorite trade in rates for 2011,” Morden, who’s based in Stamford, Connecticut, said in a phone interview.

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