Brazil Futures Yields Fall as Annual Inflation Slows to Below 5%

Yields on Brazilian interest-rate futures dropped after a government report showed annual inflation unexpectedly slowed to less than 5 percent for the first time since 2010.

Traders are betting policy makers will cut the benchmark Selic target lending rate by a half-percentage point to 8 percent next month, extending the most aggressive rate reductions among G-20 nations. The real fell, erasing earlier gains, a day after the central bank offered currency swap contracts to support the exchange rate.

“The inflation statistic was surprising,” said Newton Rosa, chief economist at SulAmerica Investimentos, in a phone interview from Sao Paulo. “It reinforces the existing expectations of another cut in the Selic.”

The yield on the interest-rate futures contract due in January 2014 fell five basis points, or 0.05 percentage point, to 8.28 percent. It was the eighth decrease in nine days. The real depreciated 0.5 percent to 2.0328 per dollar, after earlier gaining as much as 0.5 percent.

The annual inflation rate slowed in May to 4.99 percent from 5.10 percent in the previous month, the government’s statistics agency said in a report distributed in Rio de Janeiro today. The median forecast of economists in a Bloomberg News survey was for a reading of 5.06 percent.

The central bank offered swap contracts yesterday for a sixth day since mid-May to support the exchange rate. The bank said yesterday it sold 20,300 out of the 40,000 currency swap contracts it offered.

Policy Reversal

The swaps are a reversal of the bank’s stepped-up dollar purchases, which reached $7.2 billion in the foreign-exchange market in April, the most in 13 months, aimed at weakening the real to support exporters. The real is the worst performer this year among 25 emerging market currencies tracked by Bloomberg, having weakened 8.2 percent.

The currency dropped today as traders bet yesterday’s swap-triggered gain of 1.8 percent would be hard to sustain, according to Hideaki Iha, currency trader at Fair Corretora de Cambio e Valor in Sao Paulo.

“This is an adjustment,” Iha said in a phone interview. “The market’s window is very small, and so the market is very sensitive. People see some room to buy since the real was hitting 2.05 per dollar the last time the bank intervened.”

The real appreciated earlier today on speculation the government may expand its stimulus policy amid weakening growth forecasts, according to Rosa.

Tracking Dollar Index

The central bank began in April using the Dollar Index, an Intercontinental Exchange Inc. measure of the U.S. currency against counterparts including the euro and yen, to decide when to intervene, columnist Cristiano Romero reported in Valor Economico, citing an anonymous source.

The bank acts when the real strays from the gauge’s movement, Sao Paulo-based Valor reported, adding that the bank began focusing on the Dollar Index after the Brazilian currency’s decline soured foreign investors’ perceptions.

Aloisio Teles, head of fixed-income Latin American trading for Nomura Holdings Inc., recommended in an e-mailed note that clients track the real’s movement against the Dollar Index to help predict the “likelihood” of bank interventions.

Economists trimmed their 2012 economic growth forecast to 2.72 percent from 2.99 percent a week earlier, according to the median forecast in a weekly central bank survey of about 100 analysts published June 4. The economists cut their outlook for inflation this year to 5.15 percent from 5.17 percent. The rate has remained above the 4.5 percent midpoint of the central bank’s target range for 21 months.

Target Lending Rate

Policy makers reduced the target rate by a half-percentage point to a record low 8.50 percent last week, citing “fragility” abroad that is having a “disinflationary” effect on Latin America’s biggest economy. Brazil has lowered the target rate by 4 percentage points since August, the most among Group of 20 nations.

To promote growth, the government has increased subsidized credit by the state development bank, known as BNDES, and cut taxes on consumer and industrial goods. The latest round of stimulus measures last month included tax cuts on vehicles, whose sales plunged 11 percent in April and 10 percent in May.