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The yield curve has fallen over the last three weeks as the Central Bank’s Monetary Policy Committee (Copom) signaled that it is likely to end the tightening cycle in May after raising the Selic, Brazil’s benchmark interest rate, to 12.75%.
Market agents not only removed bets on a longer cycle as a result. They also started to see cuts totaling 250 basis points in 2023 – around two times what they projected in March 16, the last meeting of the Copom.
Since then, the market has bought into the Central Bank’s statements that the tightening cycle will end in the next meeting of the Copom, and now consider in the future interest curve an interest rate between 12.75% and 13% for this year. In the period, the two-year rate, more associated with short-term inflation, dropped almost 100 basis points, to 12% from 12.935%. The five-year rate also saw a crucial loss of risk premium, to 11.10% from 12.17% — falling below the level seen before the war.
“There was a very strong repricing of the curve as the Central Bank was more emphatic in its statements about stopping the tightening cycle and insisting that the 12.75% level is enough for inflation convergence [with the target],” said Filippe Santa Fé, a fixed-income manager at ASA Hedge. “In this context, it is normal for the market to bet that the rate will plummet along the curve.”
The still challenging inflation scenario is key for the market to adopt a structural bet on lower future interest rates. BTG Pactual projects that the IPCA, Brazil’s official inflation rate, is likely to peak between April and May. This factor, added to the prospect of the end of the tightening cycle, is expected to remove more premium from the fixed rate curve ahead, said economist Álvaro Frasson.
“We see an important disinflation ahead, even though it will be slower than expected,” he said. “The Selic will probably be forced to remain high, between 9% and 10%, in order to deal with any fiscal risk.” BTG estimates that the Central Bank will not be able to interrupt the tightening in May and will raise the benchmark interest rate for the last time to 13.25% in June. The bank foresees a rate of 9.5% at the end of 2023.
The pricing extracted from the yield curve points to a scenario for the moment in which the Selic will end 2022 between 12.75% and 13%, then decline to 10.5% in 2023, still well above the median of 9% of the most recent Focus, Central Bank’s weekly survey with economists. Before the last meeting of the Copom, nominal market rates projected a basic interest rate of 13.5% at the end of this year and 12.25% at the end of next year.
“I don’t think a 250-basis points cut is too much, given that the Selic is likely to have risen more than 1,000 points by the end of the cycle,” said Vinicius Alves, a strategist at Tullett Prebon. The market underestimates the risk of an accelerated tightening in the United States that could limit the eventual impetus for interest rate cuts, he added. “That’s something that would cause the dollar to gain ground globally, pick up inflation and require the [Brazilian] central bank to keep a tight policy for longer,” he said.
Christiano Clemente, the chief investment officer of Santander Private Banking, is dissenting from the recent pricing of Selic declines. “The market is thinking that the Central Bank will stop raising in the middle of this year and, in a matter of four to six months, start to cut the rate,” he said. “It doesn’t make sense to me to raise interest rates and then start cutting them soon after. The most reasonable thing would be a rate that remains constant over a certain time horizon.”
Mr. Clemente notes that the term structure of interest rates is back to the level seen before the war in Ukraine, “returning” the post-war peak stress – the five-year rate even began to trade below the 10.16% seen before the conflict. “But no doubt the Central Bank has taken over the narrative and the more appreciated exchange rate has also helped the curve to fall,” he said.
Mr. Santa Fe also added a caveat about the rates, saying that the high inflation and pressured cores, as well as above-target inflation expectations for 2023, do not support a bet on an end to tightening, let alone monetary easing. “I think we will have a partial correction of this movement,” he said. “The exchange rate has helped the curve to fall and an interruption in that dynamic could lead to a rate adjustment.”
In fact, this was the tone on Tuesday: the rates saw strong advances, reflecting the general movement of higher global interest rates, especially in the U.S. The interbank deposit rate for January 2024 rose to 12% from 11.82%, while the rate for January 2027 rose to 11.1% from 10.85%.
It draws the attention of financial agents that the curve has deepened its “inversion” – that is, the difference between the two- and five-year interest rates became even more negative.
Huang Seen, head of fixed income at Schroders, says that short interest rates have remained high, but long rates have declined with foreign capital inflows.
Source: Valor International