Brazil Traders Undermine Meirelles Rebound as Future Rates Rise

By Andre Soliani and Fabio Alves
July 22 (Bloomberg) -- Brazilian central bank President Henrique Meirelles, forecast to cut borrowing costs for a fifth straight time at a meeting today, will reverse course by early next year, the futures market shows.
The one-day loan contract for January 2011 delivery yields 0.41 percentage point more than the bank’s current 9.25 percent benchmark rate target, indicating traders anticipate Meirelles will raise the rate to 11.9 percent over the next 18 months, according to data compiled by Bloomberg. The January 2011 contract yielded 0.63 percentage point less than the benchmark target at the start of June.
The widening gap is pushing up corporate borrowing costs, dulling Meirelles’s efforts to pull Latin America’s biggest economy out of a recession by cutting the short-term rate to a record low. Concern the recovery will fuel inflation is prompting investors to bet on rate increases, said Zeina Latif, chief economist with ING bank NV in Sao Paulo.
“Brazil hasn’t achieved the conditions needed to keep interest rates at the current level for a long period,” Latif said in a telephone interview. “It will be hard to avoid raising rates next year.”
Banco Central do Brasil will cut the benchmark rate a half- percentage point today to 8.75 percent, according to all but one of the 50 economists surveyed by Bloomberg.
Policy makers have trimmed the overnight target from 13.75 percent at the end of last year. The rate target was 24.5 percent six years ago. The cuts have sparked gains in short-term bonds. The yield on the government’s zero-coupon bonds due in July 2010 has dropped to 9.03 percent from 12.15 percent at the end of last year, according to Banco Votorantim.
Meirelles’s Comments
The spread between the overnight target and the futures rate will widen by year-end, driven in part by speculation that a recovering global economy will fuel inflation and rate increases across the world, said Roberto Padovani, chief strategist at Banco WestLB in Sao Paulo.
Brazilian economists pushed up their forecast for 2009 inflation the past three weeks to 4.53 percent, above the government’s 4.5 percent year-end target, according to the median of about 100 forecasts in a central bank survey.
Meirelles, 63, sought to quell rate-increase speculation by telling investors at a July 14 conference in Sao Paulo that future yields were based on an inflation outlook “that maybe is not adequate to Brazil.” The comments helped drive down the yield on the January 2011 future contract 23 basis points, or 0.23 percentage point, over the past six days.
‘Key Factor’
Policy makers are scheduled to announce their rate decision today after 5 p.m. New York time.
While the central bank controls the overnight target, commercial banks use future yields to set rates on most prime corporate loans maturing in more than a year, according to Miguel de Oliveira, vice-president of ANEFAC, a Sao Paulo-based group that represents finance and accounting executives. About 47 percent of all Brazilian loans have a maturity of more than one year, data compiled by the central bank show.
“The yield curve is the key factor,” said Newton de Camargo Rosa, chief economist at Sul America Investimentos in Sao Paulo. “Interest-rate futures at these levels push borrowing costs higher, curbing a pickup. Maybe this is what Meirelles was concerned about.”
Economists forecast Brazil’s gross domestic product will shrink 0.3 percent this year before rebounding to post 3.6 percent growth in 2010, according to the central bank survey, which was taken on July 17.
‘More Dovish’
Meirelles, a former FleetBoston Financial Corp. banker, has supporters who share his view that the yield gap has widened too much. Geoffrey Dennis, the Latin America equity strategist at Citigroup Inc., told a conference in New York on July 15 that “Meirelles is probably right” and the “market is wrong” on interest rates.
Paulo Leme, chief Latin America economist at Goldman Sachs Group Inc., said traders have overshot how much the central bank will raise rates. He predicts the bank will boost the overnight target to between 11 percent and 11.5 percent, less than the future market’s anticipation of an 11.9 percent rate by January 2011. Future yields show the central bank will raise the rate to 13.5 percent by January 2012.
“I’m more dovish than the yield curve is,” Leme said in a telephone interview from Miami. The economic recovery will be slow, he said. “I don’t see inflationary pressures picking up in the near future.”
2002 Elections
Leme points to next year’s elections to replace President Luiz Inacio Lula da Silva as an additional cause of the swelling yield gap. Investors worry about “who’s going to be the new finance minister and the central bank president,” he said.
“Markets command a premium over the unknown,” Leme said. “Regardless of who wins the elections, whether it’s an opposition candidate or government candidate, there’s always some risk premium of possible changes in the macroeconomic regime.”
Investors pulled money from Brazil in the run-up to the 2002 presidential election, sending the currency to a record low of 4.0040 reais per dollar that October and prompting the central bank to raise the benchmark rate 8.5 percentage points in five months. The real has gained 22 percent this year to 1.8980 per dollar.
Some investors are concerned that the next president, who takes office in January 2011, will fail to stem a rise in government spending, said Nathan Blanche, a partner at Sao Paulo-based consulting firm Tendencias Consultoria.
Spending, excluding interest-rate payments, rose to 32.5 percent of gross domestic product in 2008 from 25.5 percent in 1994, according to data compiled by the Organization for Economic Cooperation and Development.
“There are clear signs public accounts are deteriorating,” said Blanche, who co-founded Tendencias in 1996. “Traders have every right to charge a risk premium.”