Brazil’s “hawkish” tone reduces demand for CPI-linked bond

(Bloomberg) – The bond market has started betting that Brazil’s central bank will control inflation.

Since December, investors have been looking for signs that Brazil’s central bank will accelerate the pace of its interest rate hikes along with rising inflation and higher growth as the country emerges from the pandemic.

They finally found them on Tuesday when the minutes from the last meeting showed officials considered surprising the market with a rate hike above the 75 basis point hikes set during the last three meetings.

The more hawkish tome sharply reduced demand for inflation-linked bonds, which last month saw an increase in purchases at auctions. The rate swap curve has also flattened: the gap between contracts expiring in early 2029 and 2022 has narrowed by 35 basis points this week as traders are betting that the next rate change will be an increase of 100 basis points. And the two-year breakeven rate, a bond market indicator of expected inflation, fell to 4.85%. That fluctuation corresponds to a drop of 65 basis points from the five-year high reached last month, while the premiums that investors were willing to pay for the inflation-protected bonds fell.

“The central bank is no longer behind the curve,” said Gustavo Medeiros, deputy director of research at the Ashmore Group in London.

The possible acceleration of interest rate increases comes just after the Federal Reserve accelerated its expected timeline to tighten monetary policy and indicated that it is ready to begin discussing when to cut back on bond purchases that have kept rates low. long term. The signals from the Fed could pressure emerging market countries to raise rates and thus prevent investors from sending cash abroad.

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Brazil was one of the first to react to the risk of rising inflation: as of Thursday, it was the only major Latin American economy that had started to reduce monetary stimulus, when Mexico did the same.

While it is not certain that Brazil’s monetary policymakers will increase the pace of rate hikes in August, the tighter stance has bolstered market confidence that the central bank will not allow inflation to spiral out of control. . That helped the Brazilian real this week to overcome the psychological level of 5.00 per dollar for the first time in a year, which could also lower the price of imports.

The change in the bank’s stance reduced interest in so-called NTN-Bs, which protect investors from inflation. The offering of 150,000 of those bonds this week was the smallest sale since March 2 and represents a sharp drop from the 5.4 million on May 25. The National Treasury generally consults traders after announcing the size of each auction, so the reduced size is a sign of diminished demand.

The impact of the tougher stance “either on the currency or on inflation expectations means that the BCB may not need to go up 100 points,” said Fernando Honorato, chief economist at Banco Bradesco SA. “I would not be surprised if we had inflation slower than expected in the coming weeks.”

Original Note: Brazil’s Hawkish Turn Ends Bond-Market Rush Into Inflation Haven

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