Bloomberg News

Chilean Traders May Be Underestimating Inflation, BofA Says

October 11, 2011

(Update with comments from finance minister in ninth paragraph, peso trading from 14th paragraph.)

Oct. 11 (Bloomberg) -- Chile’s interest-rate swaps market is pricing in less inflation than economists forecast, creating an opportunity for investors, according to Bank of America Corp.’s global research unit.

“While the inflation outlook in Chile has clearly changed with the global economic slowdown, a one-year breakeven rate of 2.4 percent does not fully take into account potential upward risks to headline inflation,” strategist Ezequiel Aguirre wrote today in a note to clients.

Breakeven inflation is a measure of the average future pace of price rises as reflected by the difference between nominal and inflation-linked yields. In Chile, the one-year breakeven rate as measured in the swaps market fell to 2.38 percent as of 2:30 p.m. New York time today from 2.62 percent a month ago.

The one-year interest-rate swap in pesos reached a nine- month low of 4.05 percent on Oct. 4 as traders priced in faster and deeper interest-rate cuts. Plunging peso yields have narrowed the gap with inflation-linked yields, leading to breakeven inflation lower than economists’ forecasts.

The one-year swap rate in pesos rose 10 basis points, or 0.10 percentage point, to 4.36 percent today and the one-year inflation-linked rate rose 13 basis points to 1.93 percent.

Wider Gap

Investors should pay fixed interest rates in pesos and receive fixed interest rates denominated in unidades de fomento, Chile’s inflation-linked accounting unit, Aguirre wrote. That would position them to profit from a wider gap between the two.

Chile’s central bank targets 3 percent inflation over a two-year horizon with a margin of error of 1 percentage point on either side.

The median forecast of 50 traders and investors in a central bank survey on Sept. 27 was that prices would rise 2.8 percent in the next 12 months. The median forecast of more than 60 economists in a Sept. 9 survey was that prices would rise 3 percent in the year to August 2012 and 3 percent again in the calendar year 2012.

The bank is scheduled to publish results of the latest surveys tomorrow. The bank, which meets this week, has room to lower rates, Finance Minister Felipe Larrain told reporters in Santiago today.

“We have room for maneuver, as much in monetary policy as in fiscal policy,” Larrain said.

Derivatives Tax

Larrain was promoting Chile’s new derivative law, which was approved by Congress last week. The new rules seek to clarify tax treatment for derivatives, including forwards, futures, swaps and options. Previously tax treatment of derivatives was governed by a series of findings from the country’s internal revenue service, rather than by a single law.

By making tax treatment of derivatives easier to understand, the government hopes to promote the use of hedging and mitigate the effects of currency fluctuations on small and medium-sized businesses. More than 600 Chilean companies had used currency derivatives to hedge in the last month, Larrain said.

Chile’s peso strengthened today as traders, returning from a long weekend, priced in yesterday’s gains in other emerging- market currencies and real-money investors took advantage of a mid-morning decline in the peso to buy.

Trading Resumes

The peso gained 1.8 percent to 509.38 per U.S. dollar from 518.5 on Oct. 7, the steepest appreciation among the seven Latin American currencies tracked by Bloomberg. Yesterday was a trading holiday in Santiago.

After opening at 510.75, the currency retreated to an intraday low of 517.69 as copper fell on renewed concern about the European debt crisis. Copper accounts for most of Chile’s exports, so higher copper prices increase the country’s dollar income and boost the peso.

“Yesterday markets were pretty positive outside Chile, but lack of liquidity and falling copper then took the peso back to 517 per dollar,” said Eugenio Cortes, head of currency forwards at EuroAmerica Corredores de Bolsa SA in Santiago. “Then some real offer started to appear: pension funds and offshore banks who are still long the dollar started selling dollars and that pushed the peso back.”

Foreign investors in the Chilean peso forwards market, including offshore branches of banks, had increased long positions in the dollar versus the Chilean currency to $6.5 billion on Oct. 6, the most since May 2010, according to central bank data.

Europe Debt

Copper rose to the highest in almost two weeks yesterday after the leaders of France and Germany pledged a plan to stem Europe’s debt crisis in three weeks.

“The risk of disappointing policy delivery from Europe remains high,” said Flavia Cattan-Naslausky, a currency strategist at RBS Securities Inc. in Stamford, Connecticut. “Copper prices have had a decent rebound, the question is whether that is just a temporary move.”

RBS is cautious on the Chilean peso after the central bank on Oct. 7 said it would continue buying $50 million a day, Cattan-Naslausky said. The bank has been buying dollars daily since January as part of a $12 billion plan to weaken the currency and build reserves.

--Editors: James Attwood, Glenn J. Kalinoski

To contact the reporter on this story: Sebastian Boyd in Santiago at

To contact the editor responsible for this story: David Papadopoulos at

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