The challenge of inflation, which was already a tough one, has become even more arduous. Inflation medium-term expectations are increasingly unanchored considering projections of market economists and the inflation priced into financial assets. The consequence is clear in the behavior of the interest rate market, which has come under pressure amid the perspective of even higher rates for a long period of time.
Strong swings in the rates of the NTN-Bs, the government bonds pegged to Brazil’s official inflation index IPCA, shows a worsened perception of inflationary risk ahead. The inflation priced by NTN-Bs maturing in August is close to 9% — it reached 8.73% on Friday. Expectations seem to be increasingly unanchored even for those with longer maturities. The inflation priced by the NTN-B maturing in August 2050, which started the year at 5.19%, reached, at the end of last week, 6.39%.
“The market has been pricing the gasoline lag in recent days. People start to account for the impact of the adjustment on fuel prices and its side effects. From there, they start to include inflation premiums in the curve,” said Pedro Nunes, ACE Capital’s fixed income manager, when justifying the strong upward movement of inflationary expectations in the market. On Monday, Petrobras unveiled an 8.8% adjustment in diesel prices at the refineries but kept gasoline prices unchanged.
The strong rise in fuel prices abroad also helps explain the recent advance of the breakeven inflation, said Maurício Patini, Brazil interest rate manager at Absolute Investimentos. He added that the current inflation data for the first quarter of the year also help explain the rise in market inflation, since they are higher than expected.
According to Mr. Patini, this generates more revisions due to the high correlation with a large part of regulated prices “and shows that the Central Bank’s job has become more difficult, given that inflation is widespread.”
Not coincidentally, interest rate futures have been under considerable pressure in recent days, as the market begins to see more clearly the Selic, Brazil’s benchmark interest rate, at an even higher level for a longer period. “People have the end of the cycle in their minds, but we believe that since inflation is rising, it is difficult for the Central Bank to indicate that it will stop. It is a very big risk. We think that a 50-basis-point hike in the next meeting is the floor,” said Mr. Nunes, with ACE Capital.
For him, the likely adjustment in gasoline prices and a still very pressured external inflation show how difficult Central Bank’s job is now. “I think it is very risky for the Central Bank, as the policymaker, not to keep inflation in check and then be forced to raise interest rates again later on. He can’t take that risk. That is why we think the Central Bank could end up raising interest rates a little more,” Mr. Nunes said.
The concern regarding an even more challenging inflation is also materialized in the projections of market economists. Last week, J.P. Morgan raised its projection for the IPCA in 2022 to 9.1% from 8%; Safra increased its estimate to 8.1% from 7.3%; Itaú Unibanco now sees the IPCA at 8.5%, and no longer at 7.5%; Banco do Brasil raised its projection to 8.5% from 7.8%; and BNP Paribas now expects inflation to end the year at 10%, and no longer at 8.5%.
Part of the recent worsening of expectations reflects agricultural supply shocks; the proximity of the summer in the United States., which is likely to increase demand for diesel; and the possibility of European sanctions on Russian oil. “We are very likely to experience a period of major supply shortages in the next two, three months,” said Carlos Thadeu Freitas Gomes Filho, a senior economist at Asset 1. His concern is translated into a projected IPCA of 9.5% in 2022, with chances of reaching 10% with the gasoline adjustment, and 5% in 2023.
In BTG Pactual Asset Management’s macroeconomic scenario review, economist Stefanie Birman reveals that the firm now projects inflation rates of 9.7% this year and 6% in 2023. “We saw a broader rise in expectations,” she said. Ms. Birman also pointed out that, regarding the IPCA in the short term, BTG Asset expects that, in the March-May period, the IPCA will be 1 percentage point higher than the Central Bank’s projected in the March Inflation Report. Then, the monetary authority estimated that the IPCA between March and May would be 2.1%.
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The prospect of higher, resilient global inflation is increasingly present in the composition of scenarios, said Paulo Val, chief economist at Occam. “Without a doubt, it will be challenging for our Central Bank. In the past decade and the decade before, global inflation was a disinflation drive for us, and that is an important thing that has changed,” he said. Occam projects the IPCA at 8.4% this year and at 4.6% next year, with an upward bias on both forecasts.
Mr. Val expects another 50-basis-point hike in the Selic in June, to 13.25%. Then, according to him, the Central Bank is likely to wait the elections to evaluate what the new fiscal policy will be. “If they are consolidation policies, that really control spending more clearly and society perceives it that way, I think it eases monetary policy a little bit.”
The fact that inflation has been above the center of the target since the end of 2020 and above the top of the target range since the beginning of 2021 weighs on the longer horizon, Mr. Val said. “It’s a long period already.”
In addition, fiscal policy can be a big question mark in perspectives. “You have this uncertainty about what the fiscal framework will be starting next year, regardless of who wins the elections. This fans inflation,” he said. Besides this and the external challenges already mentioned, there is the fact that emerging countries have a more chronic inflation problem, Mr. Val said. “This whole environment of uncertainty around inflation generates demand for more premium, even over longer horizons.”
Source: Valor International