UBS Challenges Trader Math in ’13 Chile Rate Boost: Andes Credit

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Finance Minister Felipe Larrain
Growth is being driven by investment, not consumption, and inflation remains under control, Finance Minister Felipe Larrain told reporters in Santiago Nov. 19. Photographer: Simon Dawson/Bloomberg

Chilean traders who are wagering that policy makers will wait more than a year before raising interest rates risk underestimating the central bank’s commitment to containing inflation, according to the most-accurate forecaster.

UBS AG’s Rafael De La Fuente, ranked first among analysts based on a two-year history of rate predictions compiled by Bloomberg, says the threat Banco Central de Chile will boost borrowing costs as soon as the first half of 2013 has increased. Two-year interest-rate swaps have risen 16 basis points, or 0.16 percentage point, to 5.16 percent since Nov. 13, reflecting expectations policy makers will lift the benchmark rate by December 2013, according to calculations made by Banco de Chile, the nation’s largest bank.

Chile, the world’s biggest copper producer and the highest-rated country in Latin America, has resisted cutting rates or easing bank-reserve requirements longer than any emerging market with below-target inflation. After increased retail sales and a surge in mining investment helped fuel 5.7 percent economic growth in the third quarter, the minutes of the Nov. 13 central bank meeting to be released tomorrow may show policy makers are starting to consider a rate rise from 5 percent, De La Fuente said.

“Chile is an economy that needs to put the brakes on,” De La Fuente, senior economist for Latin America, said by telephone from Stamford, Connecticut on Nov. 19. “Rates are just too low to cool off all this domestic demand.”

Credit Rating

Policy makers have kept the key rate unchanged for 10 months after a 25 basis point cut in January. The bank last discussed changing borrowing costs on May 17 when it considered reversing that reduction, according to bank minutes. De La Fuente said he wouldn’t be surprised if policy makers had considered a 25 basis-point increase at their November meeting.

Chile’s Aa3 grade from Moody’s Investors Service, the same as Japan and South Korea and five levels higher than Brazil, has helped the nation obtain Latin America’s lowest interest rates in the bond market. The government sold 10-year dollar debt last month at a yield of 2.38 percent, or 3.19 percentage points below JPMorgan Chase & Co.’s EMBI Global Index of Latin American sovereign debt. Chile’s dollar bonds traded at an extra yield, or spread, of 70 basis points over U.S. Treasuries yesterday.

The peso is the world’s third-best performing currency this year with a 8.1 percent gain against the dollar. It gained 0.2 percent today to 480.68.

Inflation Accelerates

The cost of protecting Chilean bonds against default for five years fell three basis points to 76 basis points yesterday from the end of last month, data compiled by Bloomberg show. Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent if a borrower fails to adhere to its debt agreements.

The yield on Chilean five-year inflation-linked benchmark bonds rose to 2.54 percent on Nov. 23, the highest level of the year, as traders bet on higher benchmark rates. The yield fell one basis point to 2.53 percent yesterday.

Inflation has accelerated for the past three months, reaching 2.9 percent in October, and may be put under additional pressure if domestic demand continues to increase, policy makers said in their rate meeting that month.

Two-year breakeven inflation, which is derived from the difference between nominal and inflation-linked yields on swaps, has increased 26 basis points to 2.85 percent since the end of last month as inflation expectations rise.

Mining Boom

A mining boom in Chile’s northern desert about 770 miles (1240 kilometers) north of Santiago helped pull in $17.8 billion in foreign direct investment in the first nine months of this year, a 63 percent increase from the year earlier.

That’s helped to feed a 6.4 percent increase in spending by businesses and consumers in the third quarter, the most in a year, the central bank said Nov. 20.

Economists polled monthly by the central bank have raised their 2012 growth forecast in every survey since July and now expect expansion of 5.2 percent.

“A hiking cycle should begin by the second half of next year,” George Lei, an analyst at Nomura Holdings Inc. in New York, said in a telephone interview on Nov. 20. “Domestically, very strong growth momentum could continue.”

Growth is being driven by investment, not consumption, and inflation remains under control, Finance Minister Felipe Larrain told reporters in Santiago on Nov. 19. Chile’s inflation rate is the lowest among major Latin American countries tracked by Bloomberg and its benchmark interest rate is the highest behind Brazil. Brazil, Latin America’s largest economy, reduced the overnight Selic rate to a record-low 7.25 percent in October from 12.5 percent last year.

Slowing Down

Chile’s economic growth will slow in the fourth quarter as exports contract on weaker copper prices, Larrain said. The price of copper, which accounts for more than half of Chile’s exports, has fallen 9 percent to an average of $3.63 a pound this year from all of 2011.

Industrial production is already easing. Manufacturing output declined in September at the fastest pace since the aftermath of an 8.8 magnitude earthquake that struck in February 2010.

Soaring domestic demand and weakening exports led the deficit in the current account, the broadest measure of the trade in goods and services, to widen to 7.4 percent of gross domestic product in the third quarter from 4.9 percent a year earlier.

The data show a “two-speed” economy where gains in manufacturing trail retail sales growth, Michael Henderson, an emerging-markets economist at Capital Economics Ltd., said in a telephone interview from London.

Growth Outlook

Economic growth in 2013 may defy the government’s predictions and accelerate from this year as the U.S. is expected to avert the so-called fiscal cliff of government spending cuts and the Euro area probably will avoid a breakup, Nomura’s Lei said.

The Finance Ministry expects growth to ease to 4.8 percent next year from a “little” over 5 percent in 2012.

“As Chinese data remains positive and the local economic data is good, we will start pricing in 5.25 percent in the first six months of 2013,” Sebastian Ide, the head of rates trading at Banco de Chile in Santiago, said by phone Nov. 22.

Chilean policy makers are unlikely to receive help from the government in containing domestic demand ahead of elections next year, said De La Fuente. The government has proposed a 4.8 percent spending increase for 2013.

“There is a risk that there may be hiking earlier in 2013,” De La Fuente said yesterday. “The risk of that is rising.”

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