Bloomberg News

Sub-10% Rate Forecast as Rousseff Urges Cuts: Brazil Credit

October 04, 2011

Oct. 4 (Bloomberg) -- Traders are betting Brazil’s central bank will cut interest rates to the lowest level since June 2010 after the government stepped up calls for a reduction in borrowing costs to bolster economic growth.

Policy makers will trim the benchmark Selic rate to as low as 9.75 percent by May from 12 percent, according to yesterday’s futures yields. The yield on the benchmark contracts due in 2013 have declined 22 basis points to 10.29 percent since an unexpected rate cut Aug. 31. Similar contracts in Mexico rose 31 basis points, or 0.31 percentage point, in the same period to 4.97 percent.

Speculation the central bank will accelerate the rate reduction is growing after President Dilma Rousseff said on Sept. 30 that Brazil must “take advantage” of the global slowdown to align the country’s borrowing costs, the highest among Group of 20 nations, with those of emerging-market peers. Traders who earlier predicted rate reductions would keep inflation from slowing from a six-year high are now lowering their forecasts for price increases as commodities tumble and credit growth ebbs.

“The central bank of Brazil is going to cut and cut and cut,” Pablo Cisilino, who helps manage $28 billion of emerging- market assets at Stone Harbor Investment Partners LP, said in a telephone interview from New York. “Look at commodity prices. Every price in the world is telling the market that the central bank of Brazil was right in cutting the last time.”

‘New Pathway’

Oil fell to the lowest level in more than a year and global stocks tumbled today as Europe’s debt crisis deepened. In Brazil, manufacturing shrank in September for a fourth consecutive month and the loan default rate rose in August to the highest level since February 2010.

Brazil’s central bank, led by President Alexandre Tombini, lowered the benchmark overnight lending rate by 50 basis points on Aug. 31 even as inflation quickened to 7.33 percent, joining Turkey as the second G-20 nation to lower borrowing costs. The cut came one day after Rousseff vowed to take Brazil on a “new pathway” of lower borrowing costs.

Rousseff, who took office in January, told business leaders in an event in Sao Paulo last week that it was “inadmissible” for policy makers not to take into account the possibility of a recession and even a depression in the global economy. Government efforts to contain spending are creating space for the central bank to begin a “cautious” and “responsible” cycle of rate reductions, she said.

Real Rates

Rousseff cut 50.7 billion reais ($27 billion) from the 2011 budget two months after taking office. The government also raised by 10 billion reais its target for the budget surplus before interest payments in August, two days before the central bank’s rate decision.

The central bank declined to comment yesterday in an e- mailed statement.

Brazil’s inflation-adjusted interest rates have declined to 4.7 percent from 5.5 percent in May, according to data compiled by Bloomberg. The country’s so-called real rate compares with 1.1 percent in Mexico and 2.1 percent in Indonesia. Turkey and China have negative real rates.

The “ideal” real rate should be between 2 percent and 3 percent, levels that are “similar to other emerging markets,” Finance Minister Guido Mantega told reporters in Sao Paulo yesterday.

Rousseff wants the benchmark rate to fall to 9 percent next year, newspaper Estado do S. Paulo reported on Oct. 2, citing three government officials that it didn’t identify.

Pace of Cuts

Yields on the contract due in 2013 rose 16 basis points today, indicating traders are reducing the total interest-rate cuts to 200 basis points, from 225 yesterday, according to data compiled by Bloomberg.

The central bank sees no need to cut interest rates as aggressively as it did after the collapse of Lehman Brothers Holdings Inc. in September 2008, a government official familiar with monetary policy told Bloomberg News. The official, who asked not to be identified because he isn’t authorized to discuss monetary policy, dismissed speculation that policy makers are aiming to bring the benchmark rate to 9 percent next year at the urging of Rousseff.

Brazil’s policy makers reduced the Selic rate 5 percentage points in seven months to a record low 8.75 percent in 2009 and boosted spending to shore up growth amid the global financial crisis.

The yield gap between two-year inflation-linked bonds and fixed-rated securities, a gauge of investors’ expectations for price increases, has declined to 6.18 percentage points from a three-year high of 6.53 on Sept. 21. Brazil targets inflation of 4.5 percent, plus or minus two percentage points.

Yield Curve

“The whole curve is falling,” Ures Folchini, head of fixed-income at Banco West LB do Brasil SA, said in a telephone interview from Sao Paulo. “It’s possible to talk about a single-digit interest rate in the beginning of 2012.”

The real rose 0.7 percent to 1.8773 per dollar at 10:33 a.m. New York time. The currency is down 13 percent in the past month.

The extra yield investors demand to own Brazilian government dollar bonds instead of U.S. Treasuries rose 8 basis points to 299, according to JPMorgan Chase & Co.

The cost of protecting Brazilian bonds against default rose 13 basis points yesterday to 216, according to CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market. Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent if a government or company fails to adhere to its debt agreements.

Before the cut in August, Tombini had raised rates five times in a bid to slow inflation to the government’s target in 2012. The central bank’s reversal may prompt investors to demand a higher premium to own Brazil’s debt, said Luciano Rostagno, chief strategist at CM Capital Markets.

‘Moderate’ Adjustments

“Such a brusque change of monetary policy, when you’re still confirming the external scenario, is going to have a cost for the central bank in the future,” Rostagno said in a telephone interview from Sao Paulo.

The central bank said last week in its quarterly inflation report that “moderate” adjustments in the key rate won’t compromise its goal of slowing price increases to 4.5 percent in 2012.

Consumer prices will rise 5.53 percent next year, according to a central bank survey of economists released yesterday. The median forecast has increased from 5.2 percent on Aug. 26, the last survey before the rate reduction.

The central bank “should have this opportunity to cut rates,” Stone Harbor’s Cisilino said. “But they have to keep an eye on inflation expectations, have an eye on the currency and keep their fiscal discipline at the same time, which I think they’re doing anyway.”

--With assistance from Josue Leonel and Tais Fuoco in Sao Paulo, and Andre Soliani in Brasilia. Editors: Lester Pimentel, David Papadopoulos

To contact the reporters on this story: Ye Xie in New York at yxie6@bloomberg.net; Gabrielle Coppola in Sao Paulo at gcoppola@bloomberg.net

To contact the editors responsible for this story: David Papadopoulos at papadopoulos@bloomberg.net


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