Brazil Rates Set to Surge 2.25 Points in Trading

Brazilian policy makers are poised to raise borrowing costs at the fastest pace since President Luiz Inacio Lula da Silva took office in 2003 after central bank chief Henrique Meirelles pledged “vigorous action” on inflation, the futures market shows.     The biggest two-day surge in six months on yields of the overnight interest rate futures contract due in July reflects expectations that Meirelles will raise the benchmark Selic rate 2.25 percentage points to 11 percent by the June policy meeting, according to data compiled by Bloomberg. The yield gap between the July 2010 and January 2021 futures shrank to the narrowest since August yesterday on bets higher borrowing costs now will make it possible to avoid more increases in years ahead.

Investors drove up fixed-rate bond yields on concern the central bank won’t raise rates fast enough to rein in inflation as Meirelles, 64, held the rate at a record low 8.75 percent last month as he considered a run for elected office. Yesterday he called on the next government to be “very serious” in fighting rising prices, and in an April 25 interview said the bank was ready to “take the necessary measures” to keep the economy from overheating.

“There has been some flip-flopping by the central bank and the statements were confusing,” said Kieran Curtis, who manages about $2 billion in fixed-income emerging-market assets including Brazilian bonds at Aviva Investors in London. “If they feel they need to move aggressively, they will.”

Inflation Pick-Up

Inflation in the year though mid-April accelerated to an 11-month high of 5.2 percent, above the government’s 4.5 percent target. Economists predict inflation will end the year at 5.4 percent, according to a central bank survey published yesterday.

Yields on the interest-rate futures contract due in July rose seven basis points yesterday to 9.52 percent, the highest level since June, following a six basis-point jump on April 23. They climbed another 2 basis points today to 9.54 percent as of 8:29 a.m. New York time.

The increase in the July contract reflects expectations policy makers will raise the benchmark Selic rate 75 basis points, or 0.75 percentage point, at their two-day meeting that starts today and at each of the next two meetings, Bloomberg data show.

2021 Contracts

The yield on contracts maturing in January 2021 fell 22 basis points in the past two days to 12.59 percent as traders bet higher interest rates will contain inflation expectations in years ahead. It dropped another 1 basis point today.

The yield gap between the January 2021 and July 2010 contracts narrowed to 3.07 percentage points yesterday, the smallest difference in at least eight months, from 4.1 percentage points at the end of last year.

Brazil’s real weakened 0.4 percent today to 1.7529 per dollar, its first drop in three days.

Finance Minister Guido Mantega said in New York yesterday that the government may take more measures to limit gains in the currency. The real hasn’t traded beyond 1.69 per dollar since October, when the government levied a 2 percent tax on foreign purchases of stocks and bonds to arrest the currency’s appreciation. The real will end the year at 1.75 per dollar, according to the median forecast of 17 economists.

Dollar Bonds

The extra yield investors demand to own Brazilian dollar- bonds instead of U.S. Treasuries widened five basis points today to 1.81 percentage points, according to JPMorgan Chase & Co. indexes. The yield gap touched 1.67 percentage points on April 15, the narrowest since October 2007. The average spread for emerging-market dollar debt overall grew 7 basis points to 2.51 percentage points.

The cost of protecting Brazilian bonds against default for five years rose two basis points to 118 basis points, according to CMA DataVision prices. The cost dropped to 110 basis points on April 15, the lowest in seven months.

Marfrig Alimentos SA, the world’s fourth-largest meatpacker, plans to sell 10-year dollar bonds as soon as this week to take advantage of falling borrowing costs, a person familiar with the transaction said yesterday. The yield on the Brazilian company’s 9.625 percent note due in 2016 dropped 0.76 percentage point to 8.76 percent this year, according to Bloomberg data.

Rising Inflation

Traders’ expectations for inflation have surged since the March 17 policy meeting where the central bank’s decision surprised more than half of the 57 analysts who predicted an increase in a Bloomberg survey.

Yields on government 10 percent fixed-rate bonds due 2013 climbed 65 basis points to 12.67 percent since the meeting. The yield on the inflation-linked bond due that year fell 35 basis points in the first 15 days after the decision to 6.2 percent before climbing to 6.7 percent yesterday. The gap between the two securities touched the widest since January 2008 on April 23.

Investors are pricing in too many interest-rate increases and betting on a further advance in bond yields would be unprofitable, said Guillermo Osses, who helps oversee $50 billion in emerging-market assets at Newport Beach, California- based Pacific Investment Management Co., manager of the world’s biggest bond fund.

‘Target Band’

“This has been one of the central banks in the world that has been able to keep inflation within its target band,” said Osses, who predicted the central bank will raise the Selic by 50 basis points tomorrow and by 3 percentage points at most by mid-2011.

Policy makers haven’t lifted the benchmark rate by as much as 2.25 percentage points in a three-month period since raising it 4.5 percent percentage points between December 2002 and February 2003. Lula, 64, who steps down at the end of this year, took office that January.

“If they go for 50 basis points now rather than 75, the risk is that market expectations for inflation continue to worsen,” said Marcelo Carvalho, chief Brazil economist for Morgan Stanley, who raised his forecast for growth this year to 6.8 percent from 5.8 percent. “Then the central bank finds itself forced later on to do more than it may have planned initially.”