Lula Gains as Greenspan ‘Conundrum’ Cuts Yields: Brazil Credit

The biggest foreign purchases of Brazilian local bonds in three years are pushing longer-term borrowing costs below yields on two-year debt for the first time since October 2008.

Yields on fixed-rate government bonds due in 2017 have declined 106 basis points, or 1.06 percentage points, in the past three months to 11.49 percent. The plunge in 2017 yields put them as much as eight basis points below yields on notes maturing in 2012 last week. A year ago, longer bonds yielded 171 basis points more than the shorter-term securities.

Record low yields in the U.S. and Europe spurred foreigners to buy a net $16 billion of Brazilian bonds from January through July, compared with $9.1 billion for all of 2009, according to the central bank. International investors are piling into longer-term debt, helping trim President Luiz Inacio Lula da Silva’s borrowing costs, in part as a bet slowing inflation will push down rates in coming years, according to Citigroup Inc.

“We are seeing relentless inflows,” Dirk Willer, head of Latin America local markets strategy at Citigroup in New York, said in a telephone interview. “Some of the investors are betting on the convergence trade.”

Brazil’s so-called inverted yield curve is similar to the “conundrum” that former Federal Reserve Chairman Alan Greenspan said he faced in 2005, according to Marcelo Saddi Castro, who oversees 18 billion reais ($10.3 billion) as chief investment officer at SulAmerica Investimentos in Sao Paulo.

Rate Increases

That February, Greenspan said in a speech that he was puzzled by a decline in long-term bond yields even after he boosted the benchmark overnight rate six times in eight months. Brazilian long-term yields are declining after central bank President Henrique Meirelles boosted the interbank rate to 10.75 percent from a record low 8.75 percent in April to cool growth.

Like foreigners’ purchases are pushing down Brazilian long- term rates now, yields on 10-year Treasuries sank then as countries from China to Saudi Arabia invested cash from trade surpluses in long-term U.S. debt.

“An inverted curve is not something common in Brazil,” Saddi Castro said in a telephone interview. “There’s huge liquidity in the markets and you have a strengthening of flows from foreigners, which was exactly what happened in the U.S. There are some similarities.”

Overseas investors increased their holdings of Brazilian domestic debt to a record 9.5 percent of the total in July from 6.1 percent a year earlier, according to Fernando Garrido, head of the government’s Public Debt Operations Department. Foreigners “prefer” bonds maturing in at least four years, Garrido said in a telephone interview on Aug. 26.

‘Breakout Phase’

International investors held 61 percent of the government’s bonds due in 2017 as of April, up from 50 percent at the end of 2008, according to the Treasury. They owned 49 percent of bonds due in 2021. Pacific Investment Management Co., which runs the world’s biggest bond fund, is the largest holder of the bonds due in 2017, accounting for 7 percent as of June 30, according to data compiled by Bloomberg. There are currently 39.7 billion reais of the bonds outstanding.

Brazil is in a “developmental breakout phase,” Mohamed El-Erian, Pimco’s chief executive and co-chief investment officer, said in a July 27 radio interview with Bloomberg.

Latin America’s largest economy will grow 7.1 percent this year, the fastest pace in two decades, according to a central bank survey of about 100 analysts released Aug. 23.

U.S. Yields

Global pension funds and Japanese investors increased their purchases of Brazilian debt as yields fell in the U.S. and Japan amid signs the world economy is slowing, according to Willer. Two-year U.S. Treasury notes yielded a record low 0.45 percent on Aug. 24 while 10-year Japanese bonds reached a seven-year low of 0.91 percent the following day.

The extra yield investors demand to hold Brazilian government dollar bonds instead of U.S. Treasuries widened 12 basis points last week to 216, according to JPMorgan Chase & Co.

The cost of protecting Brazilian debt against non-payment for five years with credit-default swaps rose seven basis points to 128, 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.

The real gained 0.4 percent last week to 1.7501 per dollar.

‘Great Opportunity’

Brazil’s benchmark overnight interest-rate equals 6.15 percent after adjusting for inflation, the second highest among 54 nations tracked by Bloomberg. The annual inflation rate has declined to 4.6 percent from 17 percent in 2003 as Lula pared the budget deficit as a percent of gross domestic product and the currency rallied 102 percent against the dollar.

Brazil’s budget deficit equaled 3.4 percent of GDP in the 12 months through July, or about one third the U.S. gap.

Lula’s bonds still offer “a lot” of yield, “given Brazil’s fundamentals,” Ures Folchini, head of fixed income at Banco WestLB do Brasil SA, said in a telephone interview from Sao Paulo. “Foreign investors are looking at the long end of the curve and seeing a great opportunity.”