Bond Vigilantes Burn Sao Paulo to Whip Inflation

Thursday, 25 Jul 2013 02:46 PM

 

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Protesters who forced authorities to cut bus fares last month in Brazil’s largest demonstrations in two decades are helping inflation ease to the slowest in almost three years, providing an unintended boon to the nation’s bondholders.

Yields on the government’s fixed-rate notes due in 2023 have dropped 0.97 percentage point since reaching a 15-month high of 11.63 percent on June 21. The decline was more than three times as fast as comparable Mexican bonds as data published on July 19 showed consumer prices in Brazil rose 0.07 percent in mid-July from the prior month, the slowest increase since August 2010.

Bus fare reversals are hastening a slowdown in inflation that has exceeded the government target range twice this year, which may let the central bank curtail the fastest pace of interest-rate increases in the world, according to Banco Bilbao Vizcaya Argentaria SA. More than 1 million protesters in June demanded better public services, an end to corruption and a lower cost of living after prices for everything from housing to flour surged in the first half of the year.

“It’s good news for investors who aren’t protected against inflation,” Enestor Dos Santos, principal economist at BBVA and the top forecaster of Brazil’s rate decisions based on a two- year history of estimates compiled by Bloomberg, said by phone from Madrid. “This may even make the central bank stop raising rates in October, as opposed to November. It’s very important.”

Biggest Decline

The central bank, whose press office declined to comment whether last month’s protests are helping bondholders, targets annual inflation at 4.5 percent, plus or minus two percentage points.

The extra yield investors demand to own Brazilian government dollar bonds instead of U.S. Treasuries has fallen 43 basis points, or 0.43 percentage point, to 217 basis points in the past month, the most since October 2011, according to JPMorgan Chase & Co.

Brazil’s five-year credit default swaps, contracts protecting holders of the nation’s debt against non-payment, have fallen 29 basis points to 176 basis points in the same span.

Transportation prices in Brazil fell 0.55 percent on a monthly basis in the first half of July, the biggest decline in a year. A decline in food and clothing prices also helped offset increased housing, health care and education prices as inflation fell short of the 0.11 percent median forecast made by analysts polled by Bloomberg.

‘Main Reason’

Protests that saw demonstrators set up burning barricades and that claimed the lives of at least six people were set off in early June after the Sao Paulo government announced it was raising bus fares 7 percent. Authorities in that city and other metropolitan centers including Rio de Janeiro, Porto Alegre and Recife in June eventually bowed to demonstrators and reduced prices on city buses.

“The main reason you had a lower rate was because of the undoing of the fare increases,” John Welch, macro strategist at the Canadian Imperial Bank of Commerce, said by phone from Toronto about inflation. “You had quite a bit of backlash against inflation.”

President Dilma Rousseff is taking other steps to cool inflation, which has reduced purchasing power and contributed to a decline in her government’s approval rating. Finance Minister Guido Mantega said on July 22 the government will cut spending by 10 billion reais ($4.4 billion) in 2013 and in June authorities cut import duties on beans, a staple in the country.

Rising Dissatisfaction

Gross domestic product expanded 1.9 percent in the first quarter from a year earlier, missing analysts’ estimates for 2.3 percent growth as household spending fell to its lowest level since 2011. Growth slowed to 0.55 percent in the first quarter from the previous three-month period.

The percentage of Brazilians who were dissatisfied with Rousseff’s policy to slow inflation jumped 10 percentage points to 57 percent in June from March, according to an Ibope poll published by the National Industry Confederation June 19. The June 6-7 survey of 3,758 people had a margin of error of plus or minus two percentage points.

Brazil also is one of only three major economies tracked by Bloomberg that is raising benchmark borrowing costs this year, after policy makers cut the key rate more than any other Group of 20 nation to a record low 7.25 percent last year.

Egypt has boosted its deposit rate by a half percentage point since January and Indonesia has increased its reference rate by 0.75 percentage point.

Temporary Relief

Brazil’s central bank on July 10 raised the benchmark interest rate by a half percentage point for the second straight meeting following an increase of 0.25 percentage point in April. Borrowing costs will rise from today’s 8.5 percent to 9.25 percent by the end of the year, according to a central bank survey of about 100 economists published July 22.

Monthly inflation in July will be close to zero, Rousseff said July 17, adding that prices will slow to the central bank’s target range by year-end.

Even as reduced fare prices provide temporary inflation relief, the lower prices may not be viable in the long term, according to Tony Volpon, director of emerging-market research for the Americas at Nomura Holdings Inc. While regulated price increases are below 2 percent, inflation in other parts of the economy is closer to 8 percent, he said.

Hard Argument

The price cuts increase “the unsustainable wedge between regulated prices and free prices,” Volpon said by phone from New York. “It creates more fiscal pressure because municipalities are going to have to subsidize. It’s hard to make an argument that this is good macroeconomic news.”

Brazil’s inflation will accelerate to 5.87 percent next year from 5.75 percent in 2013, according to the July 22 central bank survey. Analysts have boosted their 2014 inflation forecast from a low of 5.50 percent at the start of the year.

Yields on interest-rate futures contracts due in January 2015 climbed six basis points to 9.34 percent yesterday. The real dropped 1.6 percent to 2.2505 per dollar and is down 8.8 percent this year, the fourth-worst performance among the 16 most-traded currencies tracked by Bloomberg.

While street demonstrations have died down this month, the uprising put policy makers under renewed pressure to follow through on their promises to rein in inflation, according to Carlos Kawall, chief economist at Banco Safra.

“There’s a perception that people pay a lot for services that are of bad quality,” Kawall said by phone from Sao Paulo. “Part of that has to do with public tariffs.”

© Copyright 2014 Bloomberg News. All rights reserved.

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