Real Bonds Post Biggest Monthly Slump Since May: Brazil Credit

Brazilian real bonds are posting the biggest monthly loss since May as accelerating inflation sparks speculation the central bank will be forced to raise interest rates after President-elect Dilma Rousseff takes office.

The 1.5 percent decline in Brazil’s local-currency debt compares with an average loss of 1.4 percent for developing- nation debt, according to JPMorgan Chase & Co. indexes.

Consumer prices in Latin America’s biggest economy climbed more than forecast in October, driving annual inflation to a five-month high of 5.2 percent. Yields on real bonds due in 2021 surged 93 basis points, or 0.93 percentage point, in the past month as Rousseff said she’ll boost payouts to the poor and may raise the minimum wage more than planned. Mexican peso bond yields rose 43 basis points in the same period.

“Inflation expectations are ticking higher and it seems like the central bank is not going to do anything about it,” said Edwin Gutierrez, who helps manage $6 billion in emerging- market debt at Aberdeen Management Plc in London.

Yields on interest-rate futures due in January 2012 surged 36 basis points in the past month to 11.64 percent, signaling traders expect the central bank will raise the benchmark rate to about 12.5 percent by the end of next year from 10.75 percent, according to data compiled by Bloomberg.

Prices as measured by the benchmark IPCA index rose 0.75 percent in October, fueled by food costs, the national statistics agency said Nov. 9. The increase was higher than the median forecast of 0.67 percent among 41 analysts surveyed by Bloomberg and surpassed all but one estimate.

Inflation Outlook

Inflation will quicken to 5.48 percent by year-end, the highest rate since July 2010, according to a central bank survey of economists released Nov. 16. A week earlier, the median forecast was 5.31 percent.

Policy makers are committed to achieving their inflation target of 4.5 percent plus or minus two percentage points, Central Bank President Henrique Meirelles said in an interview with Globo News television on Oct. 17.

The central bank said in a statement it doesn’t comment on market moves or speculation.

Rousseff, President Luiz Inacio Lula da Silva’s former cabinet chief and handpicked successor, told reporters Nov. 3 that she’s considering raising the monthly minimum wage to more than 700 reais ($406) by 2014 from 510 reais today. The increase is more than the 5.5 percent proposed in the government’s 2011 budget. Lula increased spending 27 percent in the first nine months of this year.

‘Policy Direction’

“There’s uncertainty about policy direction moving forward as the leadership of the economic team and the central bank members is unknown and the fact that inflation is a little higher,” said Paul Biszko, an emerging-markets strategist at RBC Capital Markets in Toronto.

Lula’s tripling of a tax on foreigners’ fixed-income purchases to 6 percent on Oct. 19 to slow the rally in the real is also reducing demand for Brazil’s bonds, said Kathy Jones, an emerging-markets bond strategist at Morgan Stanley Smith Barney, which manages $1.6 trillion.

Finance Minister Guido Mantega told reporters in Brasilia on Oct. 25 that the tax increase was working to curb investment in the debt market and stem the real’s gains.

“At 2 percent it wasn’t so bad, but at 6 percent it’s not making sense to take the currency risk,” said New York-based Jones. “We’re a little more cautious now then we have been. We reached the level of fair value.”

The real gained 0.9 percent yesterday to 1.7115 per dollar.

Yield Spread

The extra yield investors demand to hold Brazilian dollar bonds instead of U.S. Treasuries was unchanged at 175 yesterday, according to JPMorgan.

The cost of protecting Brazilian debt against non-payment for five years with credit-default swaps fell two basis points to 108, 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.

Yields on interest-rate futures due in January 2012 rose six basis points yesterday to 11.64 percent, according to data compiled by Bloomberg.

Inflation will slow in the first three months of next year, allowing the central bank to lower interest rates, said Aloisio Teles, co-head of emerging-market trading at Nomura Securities International Inc. in New York.

“They were expecting these levels, so it’s not new and by next year inflation will go down,” Teles said. “It’s pretty much noise and speculation about the new government and it generates great opportunity in Brazil.”

‘Cut in 2011’

Rousseff’s efforts to restrain public spending will allow the central bank to cut the benchmark interest rate next year, Mantega said on Nov. 13.

“I believe the central bank can cut in 2011,” Mantega said in an interview as he was leaving Seoul after the Group of 20 Summit. “We are going to create conditions to open a space for the interest rate to fall. How much it will fall, I don’t know, but I can assure you it will fall.”

Mantega has accepted Rousseff’s invitation to remain in his position, a person familiar with the decision said yesterday.

Rousseff’s transition team won’t comment on speculation and the president will announce her cabinet picks at the appropriate time, said one of her press officers who cannot be identified because of internal policy.

The Finance Ministry didn’t respond to a telephone call and an e-mail seeking comment.

‘Lot of Pressure’

Policy makers boosted the benchmark rate by 200 basis points from a record low of 8.75 percent in April to cool the economy’s fastest expansion in two decades.

The economy will expand 7.6 percent this year after shrinking 0.2 percent in 2009, according to the Nov. 12 central bank survey of about 100 economists.

“There’s a lot of pressure right now and the inflation concern and lack of demand will push yields higher,” said Enrique Alvarez, head of Latin America fixed-income research at IDEAglobal in New York.