Traders’ Math Made Worthless by Stealth Rate Cut: Brazil CreditDavid Biller and Blake Schmidt
The Brazilian central bank’s refusal to enforce its benchmark rate target is eroding traders’ ability to bet on monetary policy decisions and prompting economists to speculate that the inaction constitutes a stealth rate cut.
The rate that banks charge each other for overnight loans, known as DI, was 6.93 percent on Jan. 14, marking the 23rd straight day it has been more than a quarter-percentage point below the central bank’s 7.25 percent target. The 0.32 differential is more than double the average over the past decade and compares with gaps of less than 0.1 percentage point in the U.S. and neighbors Colombia and Chile.
The growing rate gap in Brazil, which was sparked by an increase in cash levels that central bank President Alexandre Tombini has left unchecked, is rendering useless traders’ models designed to calculate the probability of policy moves in coming days and months, according to Votorantim Ctvm Ltda. By allowing the overnight rate to drop, Tombini is adding stimulus to a sputtering economy without having to announce the 11th reduction in the target since 2011.
“This kind of distortion makes it almost impossible to foresee clearly” how traders are betting on future decisions, Roberto Padovani, Votorantim’s chief economist, said in a telephone interview from Sao Paulo. “If the central bank is trying to stimulate this kind of distortion to reduce capital costs in the economy as a whole, then this could be more persistent than I’d imagined.”
The differential swelled to the widest in four years excluding one-day spikes on Dec. 19, when the overnight rate sank to 6.84 percent. The gap has averaged 0.14 point in the past decade.
The central bank said in an e-mailed response that its trading desk works to keep the policy rate, known as the Selic, near the target. The Selic is the rate at which the central bank lends and borrows money with banks. The DI is the rate at which banks lend and borrow money from each other.
“The monetary policy has as its reference the Selic rate, and therefore the central bank’s trading desk operates daily to keep it close to its target,” the bank said. In recent months, the bank said, it has “systematically” taken funds from the market at a rate of 7.11 percent to 7.14 percent a year, “perfectly within the band always used.”
Central bankers are scheduled to begin a two-day policy meeting today. All 56 economists surveyed by Bloomberg predict the bank will hold the rate at a record low 7.25 percent for a second straight meeting. The bank lowered the rate target, known as Selic, 5.25 percentage points over a 14-month period beginning in August 2011 to spark an economic recovery.
With the economy posting its weakest two-year expansion in more than a decade and inflation quickening, Tombini is left to navigate between conflicting policy choices.
Speculation is increasing that his inaction in the overnight market is a designed response to that dilemma, allowing borrowing costs to fall without adding to concern that he’s not doing enough to quell inflation, said Diego Donadio, Latin America strategist at Banco BNP Paribas Brasil SA.
Policy makers may “consider the activity too weak and it’s a good idea to have a market operate with a lower rate even if the bank doesn’t need to cut rates,” Donadio said in a telephone interview from Sao Paulo. “Then the bank gains credibility but knows the market is operating at a lower rate.”
It’s the 6.93 percent overnight rate, not the central bank’s 7.25 percent target, that sets the benchmark used to determine borrowing costs on companies’ floating-rate securities, or 89 percent of all local corporate bonds, according to Brazil’s capital markets association.
Annual inflation has exceeded the 4.5 percent midpoint of the central bank’s target range for 28 consecutive months. Consumer prices surged 5.84 percent in the 12 months through December, the fastest pace since February, the national statistics agency reported Jan. 10. The government predicts inflation will slow to 4.8 percent this year while economic growth picks up to as much as 4 percent. Latin America’s biggest economy probably grew 1 percent in 2012, following a 2.7 percent expansion in 2011, according to the central bank.
Betting on policy decisions through the DI futures contracts has become increasingly difficult because traders don’t know whether the soaring gap between the overnight rate and the target is an aberration that will fade or the new norm, according to Donadio.
“You have another risk, which is the risk of this overnight rate suddenly normalizing,” Donadio said. “The overall level of swap rates can move 30 basis points higher just because the overnight rate normalizes.”
The extra yield investors demand to own Brazilian government dollar bonds instead of U.S. Treasuries rose three basis points to 144 basis points at 5:58 p.m. in Sao Paulo, according to JPMorgan Chase & Co.
The cost to protect Brazilian bonds against default for five years fell one basis point to 111 basis points. 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 real dropped 0.2 percent to 2.0364 per dollar. Yields on interest-rate futures contracts due in January 2015 increased two basis points to 7.71 percent.
The overnight rate gap has become so large that betting on whether it will converge back toward its historical level is beginning to replace the speculation on Selic rate policy decisions, according to Roberto Simoes, head of proprietary trading at BES Investimento, and Tony Volpon, head of emerging markets research for Nomura Securities International Inc.
Bloomberg data based on futures trading show that interest rates may rise as soon as this week. That may not be a bet on a Selic rate increase by policy makers, but rather a wager on a jump in the DI rate, according to Volpon.
“Some of these very small stub hikes that you have this year are really not expectations of a hike,” Volpon said in a telephone interview from New York. “They’re just expectations of the normalization of the spread.”