Investors are buying Brazil’s inflation-linked bonds and selling fixed-rated securities at the fastest pace in two years on concern central bank President Alexandre Tombini may fail to stem consumer price gains.
Debt tied to inflation rose since Jan. 19, with yields falling 7 basis points to 5.92 percent, as policy makers signaled they won’t accelerate interest-rate increases to cut inflation that’s above the 4.5 percent target. The yield gap with two-year fixed-rate bonds, a gauge of investor expectations for price rises, grew to 688 basis points, the widest since November 2008.
Tombini’s plan to rely on “macro prudential measures,” such as raising reserve requirements, to contain the fastest inflation in 25 months means policy makers may not raise interest rates quickly enough to curb prices, said Marcelo Salomon, chief economist for Brazil at Barclays Plc. The rally in Brazil’s bonds is part of growing demand for inflation protection in emerging markets after Turkey unexpectedly cut borrowing costs and Chile held rates to limit currency gains.
“There has been a paradigm shift as the central bank won’t rely upon conventional monetary policy to fight inflation,” Siobhan Morden, the head of Latin America strategy at RBS Securities Inc., said in a telephone interview from Stamford, Connecticut. “You have a central bank signaling it wants to moderate rate hikes. That seems out of sync with the market that has increased inflation expectations. You have to demand more inflation risk premium.”
Outperformance
Brazilian inflation-linked bonds maturing in less than five years returned 2.9 percent in the past three months, compared with a 1.5 percent advance for fixed-rated securities, according to the country’s capital markets association. Globally, government debt that protects against inflation posted a gain of 2 percent since August, compared with a loss of 1.1 percent for fixed-rate sovereign debt, according to Bank of America indexes.
The difference between yields on Chile’s one-year fixed- rate and inflation-linked bonds jumped to 4.29 percent this month, the highest since August, after the central bank started buying $12 billion to weaken the peso and kept its overnight interest rate unchanged for the first time in eight meetings. In Turkey, inflation-linked bonds returned 5.7 percent since October, as the central bank reduced its benchmark interest rate for a second month last week to weaken the lira.
Brazil’s central bank is reluctant to raise interest rates at a faster pace because higher borrowing costs will attract more foreign investors and boost the real, Barclays’ Salomon said. The real is up 38 percent since January 2009, the most in emerging markets.
“There’s another layer of currency constraint,” Salomon said in a telephone interview from New York. “They are in a tough spot.”
‘Adjustment’
Tombini, who succeeded Henrique Meirelles as central bank president this month, raised the benchmark rate, or Selic, for the first time since July by 50 basis points to 11.25 percent last week. The central bank said in a statement that it is beginning “a process of adjustment in benchmark interest rates whose effects, coupled with macro-prudential measures,” will help converge inflation toward its target.
Traders pared their bets on how much the central bank will raise interest rates this year after the decision. Yields on interest-rate futures due in 2012 fell to 12.37 percent on Jan. 21, indicating traders expect policy makers to boost borrowing costs to 13 percent by year-end, down from the 13.25 percent expected on Jan. 18, according to data compiled by Bloomberg.
The central bank said in an e-mailed statement that it “doesn’t comment on market tendencies.”
“They will raise rates less than the market has priced in,” Diego Donadio, a Latin America strategist at BNP Paribas, said in a telephone interview from Sao Paulo. “Inflation will surprise on the upside.”
Inflation Expectations
Brazilian consumer prices, as measured by the IPCA index, rose 5.9 percent in December from a year earlier. Economists last week boosted their inflation forecast for this year to 5.4 percent from an earlier estimate of 5.3 percent, according to a central bank survey released on Jan. 17.
BNP Paribas recommends its clients buy inflation-linked bonds maturing in May 2013. The yield on the securities will drop to 5.8 percent from 6.3 percent, according to a Jan. 20 note. The bank also said it raised its inflation forecast for this year to 6 percent and expects the rate to “breach” the upper end of Brazil’s inflation target band of 6.5 percent.
Dollar Purchases
The real declined 0.3 percent on Jan. 21 to 1.6777 per U.S. dollar on speculation the central bank purchased more than $1 billion of U.S. currency in the spot market. A central bank official declined to disclose the amount of dollars purchased, saying the bank releases results of the accounts on Wednesdays. It bought dollars in the spot market for the second time after policy makers said they sold all 20,000 reverse currency swap contracts that were offered in an auction, worth $1 billion.
The extra yield investors demand to hold Brazilian dollar bonds instead of U.S. Treasuries fell 1 basis point to 168 basis points at 6:23 a.m. New York time, according to JPMorgan Chase & Co. The real gained 0.2 percent today to 1.6749 per dollar.
The cost of protecting Brazilian debt against non-payment for five years with credit-default swaps rose 3 basis points last week to 109, according to data compiled by CMA. 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.
Inflation will slow as the government unveils measures to slow spending growth and help the central bank contain prices, according to Mariano Cirello, who manages 5 billion reais ($3 billion) in Brazilian assets as chief investment officer at Mapfre Investimentos in Sao Paulo.
‘Fiscal News’
Finance Minister Guido Mantega said on Jan. 14 that President Dilma Rousseff’s government has made no decision yet on the size of the reduction in the 2011 budget.
“Probably inflation needs a hand from the government,” said Cirello. “We don’t think inflation is going to be a really big problem in a few months, but we have to wait for the fiscal news.”
Calls to the Finance Ministry and Rousseff’s press office after business hours weren’t answered.
“No one seems to have real conviction that the government will deliver the fiscal adjustment,” RBS’ Morden said. “While we wait for all this to happen, you have to demand more inflation risk premium.”
‘Learning Curve’
Policy makers boosted reserve and capital requirements in December to slow consumer lending growth and ease inflation, removing at least 61 billion reais from circulation. The central bank estimates the move was equivalent to lifting the benchmark rate by 0.5 percentage point to a full point, said a person familiar with the bank’s decision-making process who declined to be identified in accordance with policy.
“The central bank, like in many other countries, resorts to other instruments to slow domestic demand” instead of using “orthodox” monetary policies, Barclays’ Salomon said. “The effect is not fully understood yet. We are riding a learning curve. Through the process, inflation expectations should continue to rise.”