Brazil Swap Rates Sink as Itau Sees 2013 Rate Cuts; Real Gains

Brazilian swap rates tumbled to a record as Itau Unibanco Holding SA forecast the central bank will resume cutting borrowing costs next year to bolster an economy that grew at half the pace analysts projected.

Swap rates on the contract due in January 2014 plunged 23 basis points, or 0.23 percentage point, to 6.87 percent at the close in Sao Paulo, the biggest drop since May 4. The real gained for a fourth day, appreciating 0.5 percent to 2.0774 per dollar. It rallied yesterday the most since June after Brazil removed capital controls that curbed appreciation.

Latin America’s largest economy grew 0.9 percent in the third quarter from a year earlier, less than half the 1.9 percent median forecast of 48 economists surveyed by Bloomberg, the national statistics agency said last week. Brazil’s central bank left the target rate at a record low 7.25 in November, ending 5.25 percentage points of reductions since August 2011, the most among the Group of 20 nations.

Gross domestic product “disappointed in the third quarter, and growth in 2012 and 2013 should be weaker,” Ilan Goldfajn, the chief economist at Itau, wrote in a report today. “More stimulus, including rate cuts, should follow.” The bank projects that policy makers will lower the target lending rate by 1 percentage point to 6.25 percent in 2013.

Brazil’s swap rates indicated today that traders project a 59 percent chance of a cut in borrowing costs in March, compared with a 19.5 percent likelihood yesterday.

The monetary policy committee signaled in the minutes of its Nov. 27-28 meeting, published today, that it would keep target lending rate, known as the Selic, at record lows for a prolonged period.

Rate Outlook

“The expectation of a rate increase in 2013 disappeared completely, and the market is already pricing in a 0.25 percentage point cut starting in March,” Jankiel Santos, the chief economist at Banco Espirito Santo de Investimento SA, said in a telephone interview. “The minutes are more dovish than the quarterly inflation report” published in September.

Barclays Plc reduced its 2013 target rate forecast to 6.25 percent, predicting in a report published today two reductions of 0.50 percentage point in January and March.

Yields dropped today at the Treasury’s 6.2 billion reais auction of fixed-rate zero-coupon bills known as LTNs as traders speculated interest rates will drop.

“Spreads are all tightening,” Ricardo Tibau, a fixed-income trader at Renascenca DTVM Ltda. in Sao Paulo, said in a phone interview. “There’s a market consensus that the Selic will fall.”

Auction Results

The yield on 284 million reais worth of the bills maturing in October 2013 was 6.92 percent, or 26 basis points less than the auction of similar-maturity debt Nov. 22. Yields on LTNs maturing in April 2015 and July 2016 also fell.

The real rallied a day after Finance Minister Guido Mantega told reporters in Brasilia that the government may further unwind capital restrictions put in place to curb the real’s gains and protect exporters.

Brazil reduced yesterday the maturity of foreign loans subject to a 6 percent tax to one year from two years after announcing Dec. 4 it would exempt exporters from the same level of tax on some borrowing. The real surged 1.5 percent yesterday, the biggest gain since June 29.

Policy makers maintain that the real has weakened to a level that doesn’t correspond with economic fundamentals, a central bank official with knowledge of the discussions said in an interview with Bloomberg. Traders wrongly bet that the government is working to keep the exchange rate within a range, said the official, who asked not to be identified because he wasn’t authorized to discuss the matter publicly.

‘More’ Cuts

Rolling back capital controls shows the government is less likely to use a weaker real to stimulate growth, said Vladimir Caramaschi, the chief strategist at Credit Agricole Brasil SA.

“The possibility of more rate cuts has gained strength because the central bank did not sanction attempts to further weaken the real,” Caramaschi said in a phone interview from Sao Paulo. “If they don’t use the currency, the chance of using rates increases.”

Policy makers have swung in 2012 between selling currency swaps aimed at preventing the real from depreciating too quickly and offering reverse currency swaps to protect exporters by keeping the real from strengthening.

The central bank sold $2.1 billion in currency swaps in two auctions on Dec. 3 and $1.6 billion in a Nov. 23 offering to stem the real’s declines. From August through October, the bank sold reverse currency swaps to keep the real weaker than 2 per dollar.

Before it's here, it's on the Bloomberg Terminal. LEARN MORE