Brazil Rate Futures Drop Most in Two Months on Slowing Growth

Brazilian traders are paring bets for interest rate increases at the fastest pace in two months as the economy shows signs of slowing.

Yields on rate futures contracts due in January 2011 declined 15 basis points, or 0.15 percentage point, in the past two weeks, the most since May, to 11.21 percent. The plunge puts traders’ year-end forecast for the central bank’s benchmark Selic overnight rate at 11.7 percent, below the consensus economist forecast of 12 percent for the first time since at least September, according to data compiled by Bloomberg.

Latin America’s largest economy may be cooling from a 9 percent annual pace in the first quarter, the fastest since 1995, after reports showed that increases in industrial output and retail sales slowed more than analysts forecast in May. Future yields are sliding from their highest level in 16 months at the end of June.

“It’s impossible for Brazil to maintain these China-like quarterly growth rates,” said Aryam Vazquez, an emerging markets economist with Wells Fargo & Co. in New York. “We’re seeing an economy that is easing towards more sustainable levels. The past couple of data readings have certainly reduced the prospects for more aggressive monetary tightening.”

The year-end traders’ forecast is down from about 12.5 percent in September, according to data compiled by Bloomberg. Central bank President Henrique Meirelles has raised the rate 150 basis points to 10.25 percent from a record low of 8.75 percent in April. The futures market shows he will lift borrowing costs at least another 50 basis points at a meeting next week.

Tax Cuts

Brazil’s economic growth will ease in the third quarter after the government withdrew stimulus measures including tax cuts, Finance Minister Guido Mantega told reporters in Brasilia yesterday.

Gross domestic product will expand between 5.5 percent to 6 percent in the third quarter and as much as 7 percent for the year, Mantega said. The International Monetary Fund increased its 2010 growth forecast for Brazil to 7.1 percent last month from a 5.5 percent prediction in April.

“The market may keep reducing their expectations for hikes,” said David Beker, the head of Latin American economics at Bank of America Merrill Lynch in New York. “The assumption a few months ago was that inflation will remain under pressure and that activity won’t slow down. Then both things happened, so people changed their rates expectations.”

Slowing Inflation

The annual inflation rate dropped to 4.8 percent in June, the lowest since February, from 5.2 percent in May as food prices declined, the government reported on July 7. The central bank targets inflation of 4.5 percent.

Retail sales climbed 1.4 percent in May from April, less than the 1.8 percent median forecast in a Bloomberg survey. Industrial production was unchanged, below the 1.5 percent median estimate.

The reports suggest the economy expanded 0.8 percent in the April-to-June period, the slowest quarter-on-quarter pace since March 2009, after growing 2.7 percent from January to March, according to Diego Donadio, an economist at BNP Paribas in Sao Paulo.

“The first quarter was very strong,” Mantega said in Brasilia. “From the third quarter on, growth will return to more normal levels.”

Policy makers will raise the benchmark rate to 12 percent by year-end, according to the central bank’s July 9 survey of about 100 economists. The forecast is 30 basis points above what rates traders are predicting. In September, economists were predicting a year-end 2011 rate of 9.5 percent, about 300 basis points below traders’ consensus call.

Real Weakens

“The prospect for a smaller and shorter tightening cycle is most likely temporary,” Jankiel Santos, chief economist at Banco Espirito Santo de Investimento, said in a telephone interview from Sao Paulo. Santos, the second most accurate forecaster in the central bank survey for June, predicts traders will push futures yields back higher.

The extra yield investors demand to hold Brazilian dollar bonds instead of U.S. securities rose nine basis points to 221 yesterday, according to JPMorgan. The real weakened 0.3 percent to 1.7625 per dollar.

The cost of protecting Brazilian debt against non-payment for five years with credit-default swaps rose three basis points yesterday to 124, according to data compiled by CMA DataVision. Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a government or company fail to adhere to its debt agreements.

‘Less Bullish’

As traders have pared their rate increase expectations, the yield difference between January 2011 and January 2013 contracts narrowed to a 16-month low of 69 basis points on July 5. The gap was 81 basis points yesterday.

Pacific Investment Management Co., manager of the world’s biggest bond fund, is betting yields will fall further as the U.S. recovery loses momentum and European nations struggle to finance their budget deficits, said Guillermo Osses, who helps oversee $50 billion in emerging-market assets at the Newport Beach, California-based firm.

“Now that the situation has deteriorated abroad and the inflation and retail data came lower, rates are going down,” Osses said in a telephone interview. “We have been long rates in Brazil because we have been less bullish than the consensus view on the global economy. It’s working so far and we’re not planning to change it.”