By Ye Xie and Boris Korby – Jul 20, 2010
Email Share Print
Brazilian traders are wagering for the first time since at least April that policy makers will lift the benchmark interest rate a half percentage point this week even as economists maintain forecasts for a bigger increase.

The average estimate fell to a 50 basis-point change from 75 basis points, or 0.75 percentage point, after inflation slowed, according to yields on interest-rate future contracts maturing Aug. 2. The decline marks the first time since at least April 26 that traders are betting on an increase of less than 75 basis points, according to data compiled by Bloomberg.

The call clashes with forecasts by 46 of the 49 economists surveyed by Bloomberg for the central bank to raise the overnight rate to 11 percent from 10.25 percent. Traders are trimming their prediction after Brazilian consumer prices dropped for the first time in four years, retail sales rose less than economists forecast and growth in China and the U.S., Brazil’s two biggest trading partners, slowed.

“So many things have changed since the last meeting,” said Marina Santos, an economist at Squanto Investimentos Ltda in Sao Paulo, in a telephone interview. “They will reduce the pace” of increases, she said.

Squanto is one of the three firms in the Bloomberg survey predicting a 50 basis-point increase tomorrow.


Traders are overreacting because the central bank remains focused on cooling credit growth and the labor market as the economy expands at its fastest pace since 1995, according to Eduardo Castro at Santander Asset Management, who correctly predicted last month that yields on rate futures would decline.

“I don’t think the central bank will slow the pace of interest-rate hikes without communicating it to the market first,” Castro, who helps oversee 100 billion reais ($56 billion) in Sao Paulo at Santander, Brazil’s fifth-biggest fund manager, said in a telephone interview. “Internal demand, credit and wage growth and the labor market remain very strong.”

Central bank President Henrique Meirelles, 64, has lifted the benchmark lending rate, known as Selic, to 10.25 percent from a record low of 8.75 percent in April. Yields on the Aug. 2 contract showed traders’ average increase estimate for tomorrow’s meeting fell to 58 basis points today, signaling a base-case prediction of 50 basis points.

Slowing Inflation

Yields on rate futures contracts due in January, the most traded contracts at BM&FBovespa SA, suggest the central bank will lift the Selic to about 11.3 percent by year-end, down from a 12.5 percent estimate in September, according to data compiled by Bloomberg. Economists are predicting a year-end rate of 12 percent, according to a central bank survey of about 100 financial institutions published yesterday.

Industrial output increased 14.8 percent from a year earlier in May and retail sales gained 10.2 percent, both slower than analysts forecast. Consumer prices, as measured by the IPCA-15 index, fell 0.09 percent in the month through mid-July, cutting the twelve-month inflation rate to 4.7 percent from 5.1 percent in June, the national statistics agency said today. The government targets annual inflation of 4.5 percent.

U.S. retail sales dropped for a second month in June while annual industrial-output growth in China slowed to 13.7 percent.

The extra yield investors demand to hold Brazilian dollar bonds instead of U.S. securities narrowed three basis points to 218 today, according to JPMorgan Chase & Co. The real gained 1 percent to 1.7742 per dollar.

Default Swaps

The cost of protecting Brazilian debt against non-payment for five years with credit-default swaps fell to 123, 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.

While Brazilian inflation has slowed in recent months, the outlook is deteriorating, which will prompt the central bank to maintain the 75-basis-point increase pace tomorrow, said Alejandro Cuadrado, a Latin America economist at Societe Generale SA in New York.

Economists raised their forecast for inflation over the next 12 months for a third straight week, pushing it up to 4.96 percent, according to the central bank survey released yesterday.

Rally ‘Overdone’

“Traders are reacting to the very short term data,” Cuadrado said in a telephone interview. “But I think the underlying trend in inflation and growth is still supporting a stronger reaction from the central bank. In the longer term inflation expectations have been rising and that should not give much of a breather to policy makers.”

RBS Securities Inc. recommended yesterday that its clients bet yields on futures contracts due in January will rise because the central bank is “more likely” to raise the Selic rate by 75 basis points this week.

The “rates rally looks overdone,” strategists Flavia Cattan-Naslausky and Siobhan Morden in Stamford, Connecticut, wrote in a research note yesterday.

The unemployment rate probably dropped to 7.3 percent in June from 7.5 percent the previous month, according to the median forecast of analysts in a Bloomberg survey. The government is slated to report the figure on July 22. Bank loans rose 2.1 percent to 1.5 trillion reais in May, the fastest pace in 10 months, according to the central bank.

The yield difference between January 2011 and January 2013 contracts widened to 95 basis points today from a 16-month low of 69 basis points on July 5 as traders bet smaller rate increases will boost inflation expectations in coming years.

“Investors have been changing positions from 75 basis point to 50 basis points, but I still believe in 75,” Carlos Eduardo Olinto, who helps manage 3 billion reais at Mercatto Investimentos in Rio de Janeiro, said in a telephone interview. “The first quarter was very strong.”