Brazil’s Hawkish Turn Ends Bond-Market Rush Into Inflation Haven
(Bloomberg) -- The bond market has started betting that Brazil’s central bank will get inflation under control.
Since December, investors had been looking for signals that the Central Bank of Brazil will step up the pace of its interest-rate hikes as inflation and growth jump with the nation emerging from the pandemic.
On Tuesday, they finally got it, when the minutes from the latest meeting showed that officials considered surprising the market with a rate hike that was bigger than the 75 basis-point moves enacted during the last three meetings.
The hawkish tone deeply reduced demand for inflation-linked bonds, which saw a surge in buying at auctions last month. The swap rate curve also flattened: the gap between contracts maturing at the start of 2029 and 2022 has narrowed by 35 basis points this week with traders piling on bets that the next rate move will be a 100 basis-point hike. And the two-year breakeven rate -- a bond market proxy for expected inflation -- edged down to 4.85%. That’s a drop of 65 basis points from the five-year high hit last month as the premium investors were willing to pay for inflation-protected bonds dropped.
“The central bank is no longer behind the curve,” said Gustavo Medeiros, deputy head of research at Ashmore Group in London.
The potentially stepped-up pace of interest-rate hikes comes just after the Federal Reserve sped up its expected timetable for tightening monetary policy and indicated that it’s poised to begin discussing when to taper bond purchases that have held down long-term rates. The Fed signals could put pressure on emerging-market countries to raise rates to prevent investors from sending cash abroad.
Brazil was among the first to react to the risk of rising inflation: It was the only major economy in Latin America that had started to reduce monetary stimulus until Thursday, when Mexico followed suit.
While it’s not certain that Brazilian policymakers will step up the pace of rate hikes in August, the hawkish tone has bolstered the market’s confidence that the central bank won’t allow inflation to get out of control. That helped the Brazilian real surpass the psychological level of 5.00 per dollar this week for the first time in a year, which could also drive down the price of imports.
The bank’s shift reduced interest in so-called NTN-Bs, which protect investors from inflation. The 150,000 of such bonds offered this week was the smallest sale since March 2 and down sharply from as much as 5.4 million on May 25. The Treasury usually consults dealers after announcing the size of each auction so the reduced size is a sign of diminshed demand.
The impact of the tougher stance “be it on the currency or inflation expectations means the BCB may not need to hike 100 points,” said Fernando Honorato, chief economist at Banco Bradesco SA. “I wouldn’t be surprised if we have slower-than-forecast inflation in the coming weeks.”
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