Brazil Swap Rates Plunge on Industrial Production; Real Declines

Brazil’s swap rates declined the most in a week as industrial production contracted more than analysts forecast, damping speculation policy makers will accelerate the pace of borrowing-cost increases.

Swap rates on the contract due in January 2015 fell 23 basis points, or 0.23 percentage point, to 9.67 percent. The real depreciated 1.1 percent to 2.2547 per dollar, after losing 9.4 percent in the second quarter, the worst performance among major emerging-market currencies.

Industrial production in Latin America’s largest economy posted the biggest contraction in three months in May, the national statistics agency said today. Output shrank 2 percent, surpassing the median estimate of 29 economists for a 1.1 percent decline. Nomura Holdings Inc. said Brazil may enter a recession at the end of the year.

“A decline in industrial production was forecast, but the size of the drop was bigger than expected,” Fernando Honorato, chief economist at Bradesco Asset Management, said by phone from Sao Paulo. “The central bank should maintain the pace of 50 basis-point hikes.”

President Dilma Rousseff’s administration has slashed payroll taxes for dozens of industries and cut electricity rates in a bid to boost production. At the same time, the central bank started raising interest rates in April to tame inflation that is currently above the target range.

Rate Increases

Policy makers have increased the benchmark rate twice this year from a record low 7.25 percent, lifting it by 25 basis points in April and an additional 50 basis points to 8 percent in May.

Industrial output grew 1.4 percent from the year-earlier period, missing analysts’ 2.4 percent estimate.

Rising borrowing costs around the world may further weaken Brazil’s economy, Nomura analysts including Tony Volpon wrote in a note to clients today.

“The last two months have already caused meaningful tightening of financial conditions, which will have a material impact on growth in the cases of Brazil, Mexico, and Chile,” the analysts wrote, citing the negative impact that tighter monetary policy in the U.S. might have on Brazil’s economy as it curbs capital inflows.

Yields on Brazil’s 10-year local fixed-rate bonds have risen 143 basis points in the past two months to 10.93 percent.

Growth Outlook

The central bank cut its 2013 economic growth forecast to 2.7 percent from 3.1 percent in a report published June 27. Policy makers cited “volatility as a risk factor and the tendency of the dollar to appreciate.” They projected 6 percent annual inflation, assuming the target lending rate remains unchanged, compared with a March estimate of 5.7 percent, and 5.4 percent next year, up from 5.3 percent.

The real was the worst performer today among major emerging-market currencies as global demand for the dollar increased amid speculation the Federal Reserve will reduce monetary stimulus.

“There is a repricing around the world,” Barbosa said. “The drop in the real is within the scope of what’s happening abroad.”

The central bank sold foreign-exchange swap contracts worth $3.98 billion on June 28 in two auctions to stem the currency’s two-month rout.

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