Currency

Biggest Yield Surge in 16 Months Spurred by Real’s Tumble: Brazil Credit

Brazilian policy makers took steps to prop up the real for the first time since 2009 and scaled back a local debt auction after the currency’s tumble helped drive yields up by the most in 16 months.

Yields on the government’s debt due in 2021 soared 59 basis points in the past five days, the biggest jump since the period ended May 6, 2010, to 12.26 percent, according to data compiled by Bloomberg. The yield on similar-maturity Mexican peso bonds rose 38 basis points, or 0.38 percentage point, during the same period, while that on 10-year U.S. Treasuries sank 22 and touched a record low of 1.6961 percent yesterday.

Investors are dumping Brazilian bonds after the real sank 10.4 percent in the past five days, fueling speculation inflation may quicken from a six-year high and exacerbating a sell-off spurred by faltering global growth. Traders are betting the central bank will lower interest rates at its next meeting after a surprise cut on Aug. 31 helped make the real the worst performer among major currencies in the past month.

“Real weakness and aggressive rate cuts added to inflation risk premium on the long end of curve,” said Siobhan Morden, head of Latin America strategy at RBS Securities Inc. in Stamford, Connecticut. “Longer tenors are also more sensitive to generalized external risk aversion.”

The 15.6 percent decline in the real in the past month handed investors in Brazilian local bonds a 15.3 percent loss in dollar terms, the biggest decline in emerging markets, according to JPMorgan Chase & Co. Emerging-market debt lost 8.4 percent this month, wiping out the gain for the year. U.S. Treasuries returned 1.7 percent in September, extending their gain this year to 8.9 percent.

Currency Swaps

The central bank sold 55,075 currency swap contracts in auctions, which was equivalent to selling dollars in the futures market. The last time policy makers entered the derivatives market to weaken the dollar was in June 26, 2009, according to the central bank. Yesterday’s measure marked a reversal of a 28- month-old strategy of buying dollars to weaken the currency.

“The central bank intends to keep acting in the dollar futures market as long as liquidity conditions demand,” Aldo Mendes, the director of monetary policy at the central bank, said in a telephone interview. “There’s no limit.”

Brazil sold 1.07 billion reais of fixed-rate bonds yesterday, the smallest amount this year. The total compares with 4.9 billion reais in the previous fixed-rate bond auction on Sept. 15.

“The moment is of volatility and the Treasury always seeks to act in a conservative way when this happens,” Deputy Treasury Secretary Paulo Valle said in a telephone interview from Brasilia. “The Treasury needs to pay more to sell fixed- income bonds when there is volatility.”

Rate Outlook

Traders expect the central bank to reduce borrowing costs by at least 50 basis points at its meeting on Oct. 18-19, according to data compiled by Bloomberg. Brazil joined Turkey on Aug. 31 as the only Group of 20 nations to lower rates in the past two months to shore up growth. Central bank President Alexandre Tombini cut the benchmark rate a half point to 12 percent, after raising it at the previous five policy meetings.

Consumer prices climbed 7.23 percent in the year through August, exceeding the 6.5 percent upper limit of the central bank’s target range for a fifth straight month. The bank targets inflation of 4.5 percent, plus or minus two percentage points.

The rate cut followed tax increases and trading restrictions aimed at curbing a 46 percent rally in the currency from the end of 2008 through August that eroded exporters’ profits.

‘Stronger’

“The bet the currency will fuel inflation is also impacting the rates,” Ures Folchini, head of fixed income at Banco WestLB do Brasil SA, said in a telephone interview from Sao Paulo. “In Brazil, the move is stronger because of the impact of the measures the government took to weaken the currency in the past.”

Inflation in Brazil is unlikely to quicken as global growth slows and Europe’s debt crisis deepens, said Pablo Cisilino, who helps manage about $28 billion of emerging-market assets at Stone Harbor Investment Partners LP in New York.

Stocks around the world entered a bear market with the MSCI All-Country World Index down more than 20 percent from its peak in May amid concern central banks are running out of tools to prevent a recession. The world is on the eve of the next financial crisis, with sovereign debt at its epicenter, said Mohamed El-Erian, chief executive officer of Pacific Investment Management Co.

The Federal Reserve said this week it saw “significant downside risks” in the economy and it will replace $400 billion of short-term debt with longer-term Treasuries to spur growth as the recovery flags.

‘Facing Deflation’

“Why people in Brazil are worried about inflation beats me,” Cisilino said in a telephone interview. “The whole planet is facing deflation right now. Look at what is going on in the world. The U.S. is hardly recovering. Europe is facing a potential financial crisis. Brazilians are too focused on what is happening in Brazil and the central bank is correctly understanding what is going on outside Brazil.”

The real fell 1.6 percent yesterday to 1.9055 per dollar. It touched a two-year low of 1.9549.

The extra yield investors demand to own Brazilian government dollar bonds instead of U.S. Treasuries swelled 29 basis points to 285, according to JPMorgan Chase & Co.

Today’s ‘Mantra’

The cost of protecting Brazilian bonds against default climbed 23 basis points yesterday to 219, according to CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market. Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent if a government or company fails to adhere to its debt agreements.

Yields on Brazil’s real-denominated bonds due in 2021 rose 23 basis points yesterday, the most since Sept. 2, according to data compiled by Bloomberg.

“What we are seeing is a flight to quality and this means today to put your money under the mattress,” WestLB’s Folchini said. “The mantra today is to take no risk, to leave your money in cash and this impacts mostly the long end of the curve because it’s mainly financed by foreigners.”