Brazil Yields Show Biggest Rate Increase Since ’03

Brazilian traders are betting for the first time that the central bank will raise the benchmark lending rate by 1 percentage point next month after last week’s increase failed to tame rising inflation expectations.

Yields on overnight interest rate futures contracts due in July climbed two basis points, or 0.02 percentage point, yesterday to an 11-month high of 9.7 percent. The futures rose 14 basis points since central bank President Henrique Meirelles raised the overnight Selic rate by a bigger-than-forecast 75 basis points from a record low 8.75 percent on April 28.

Bets on the first full percentage-point increase since Meirelles’s second month in office in 2003 are growing after economists drove up their year-end inflation forecast for a 15th straight week in a central bank survey published May 3. The median estimate rose to 5.42 percent from 4.25 percent in November and above the bank’s 4.5 percent annual target, as the expansion in Latin America’s biggest economy quickens.

“The front end of the curve has just blown out,” said Ram Bala Chandran, a Latin America currency and rates analyst at Citigroup Inc. in New York. “The momentum is so strong that it’s hard to step in front of it. As long as inflation is on the rise, the central bank has to go after it.”

Output Surges

Industrial production soared 20 percent in March from the year-earlier period, the biggest jump since the government began keeping records in 1991, the national statistics agency said yesterday. Banks boosted loans 17 percent in the month from a year ago to a record 1.45 trillion reais ($840 billion). The economy will grow 6.1 percent this year, the second-fastest pace in the past two decades, after contracting 0.2 percent in 2009, according to the central bank survey.

Meirelles’s interest rate increase last week topped forecasts from most economists in a Bloomberg survey. A month earlier, he held the Selic at 8.75 percent in a move that surprised 30 economists who predicted an increase. Inflation in the year though mid-April accelerated to an 11-month high of 5.2 percent.

“The mood in Brazil is that activity is very, very strong, and the central bank is behind the curve,” said Ures Folchini, executive vice-president of local markets at the Brazilian unit of WestLB AG in Sao Paulo. “The market is confused about the next move.” He said he’s sticking to his 75 basis-point increase forecast at the June 10 policy meeting as “the market is overshooting.”

Currency Falls

Brazil’s real tumbled 2.1 percent yesterday, the biggest drop since July, to 1.7648 per dollar, on concern Greece’s credit crisis will spread to other European countries, driving investors away from higher-yielding assets. It slid 1.3 percent to 1.7875 at 9:29 a.m. in New York.

The real is down 2.4 percent this year after posting a 33 percent advance in 2009, the world’s best-performing currency. The government may take additional steps to control the real should it observe “excessive appreciation,” Nelson Barbosa, the Finance Ministry’s secretary for economic policy, told lawmakers yesterday in Brasilia.      Finance Minister Guido Mantega said yesterday the government plans to make the exchange rate “less volatile” to aid growth. He said the government will announce new measures to help boost exports, which might include tax breaks.

BNDES Bonds

The government turned over 5.8 billion reais of 10 percent bonds due in 2012 and 2013 yesterday to the state development bank BNDES. The transfer is the last installment of a 180 billion real credit line authorized for the bank, the Treasury said in a statement yesterday.

The extra yield investors demand to own Brazilian dollar- bonds instead of U.S. Treasuries swelled 12 basis points to 2.18 percentage points, the widest gap since Feb. 24, according to JPMorgan Chase & Co. indexes. The average spread for emerging- market dollar debt grew 15 basis points to 2.95 percentage points.

The cost of protecting Brazilian bonds against default for five years rose 12 basis points to 130 basis points yesterday, according to CMA DataVision prices. The cost has climbed from a seven-month low of 110 basis points reached on April 15 amid mounting concern that Greece will default.

“If the global situation keeps deteriorating and all the growth assumptions come tumbling down the road, we would come to the realization that there is a disconnect” in Brazil’s rate futures market, Aloisio Teles, co-head of emerging market trading at Nomura Securities International Inc. in New York, wrote in a research note to clients yesterday.

Rising Yields

Nomura closed out its recommendation yesterday that the yield on futures contracts due in January 2012 will fall. The yield rose eight basis point to 12.54 percent yesterday, above Nomura’s “stop” level of 12.3 percent. Traders usually put stops or automatic orders to buy or sell securities at certain levels to limit losses in case the market moves against them.

Yields began rising on the July futures contract on March 24, a week after Meirelles left the overnight rate unchanged. It has risen 59 basis points since then from 9.11 percent. The yield held at 9.7 percent today.

Brazil’s fixed-rate bonds are yielding the most compared with inflation-linked notes in at least two years on concern consumer price increases will accelerate. The gap between yields on the two securities due 2013 swelled to 613 basis points, the widest since the inflation-linked notes were sold in January 2008. The so-called breakeven rate reflects expectations for average inflation during the period.

“The shift is taking place,” said Guillermo Mondino, head of Latin American research at Barclays Capital in New York. “We think they will do 75 basis points, but the market is likely to be positioning for a more aggressive hike. Activity has been very strong.”