Swaps Decline as Brazil Refrains From Lowering Inflation Target

  • Government maintained 4.5% 2018 central bank inflation target
  • Real drops as the central bank intervene to weaken it

Brazil’s swaps fell as traders wagered the central bank was more likely to cut interest rates this year after the government refrained from setting a more ambitious inflation target for 2018.

Swap rates on the contract maturing in January 2018, a gauge of expectations for interest-rate moves, dropped 0.16 percentage point, the most since May, to 12.72 percent on Friday. Speculation that the government would set a more ambitious goal for 2018 had increased in recent days, driving swap rates to a one-month high this week.

On Thursday, the National Monetary Committee, which includes central bank chief Ilan Goldfajn and Finance Minister Henrique Meirelles, kept its current inflation target of 4.5 percent in place for 2018 and reaffirmed the same goal for 2017. It kept the plan to narrow the current range of tolerance of plus or minus 2 percentage points to 1.5 percentage points in 2017 and 2018.

"Markets are pricing in higher chances of a interest rate reduction at the end of this year now," said Camila Abdelmalack, the chief economist at CM Capital Markets in Sao Paulo. "The rate spread was one of the main reasons for Brazil’s out performance this week."

The currency dropped 0.7 percent to 3.2364 per dollar as the central bank intervened to weaken it. Brazil’s monetary authority placed 10,000 reverse swaps, equivalent to buying $500 million in the futures market and has announced will place the same amount on Monday. The real has climbed the most among about 150 currencies worldwide this year, prompting the central bank to try to limit its appreciation by selling $43.3 billion in reverse swaps since March 21.
 
The real earlier rose as much as 0.5 percent and remains the best-performing currency in emerging markets this week, gaining 4.3 percent. A gauge of emerging-market currencies advanced amid speculation central banks around the world will act to limit the fallout from the U.K.’s vote to leave the European Union last week.

"Investors are looking beyond the immediate European-centric growth shock of Brexit and focusing on the implications on global central bank policy," said Mike Moran, the head of economic research for the Americas at Standard Chartered Plc. "More easing in some shape or form is bringing investors back to yield-rich markets -- the emerging market space in particular has weathered the week very well. The yield-grab is in full force and the real is benefiting from this."

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