Itaú BBA - Receive Brazilian local rates as inflation remains low and election risk declines – Local Rates Trad

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Receive Brazilian local rates as inflation remains low and election risk declines – Local Rates Trad

January 29, 2018

We recommend receiving DI Jan21 at 8.78%.

STRATEGY TEAM:
 

Ciro Matuo, CNPI, ciro.matuo@itaubba.com
Luka Barbosalbarbosa@itaubba.com
Eduardo Alonsoeduardo.marza@itaubba.com


Despite last week’s rally, Brazil’s local yield curve remains one of the steepest in the world. The market currently prices in that rates will be more than 300bps higher in 3 years relative to today, which we believe is excessive premium at this point.

Economy activity is improving, but we do not expect inflation to rise fast, because of a wide output gap (around 5% in our calculations) and low inertia. In fact, we expect 12-month services inflation to continue falling throughout this year (see chart). Our 2018 year-end headline IPCA forecast is 3.8%, counting on an increase in tradable prices (industrials, foods), but we see downside risks in case the BRL remains at current appreciated levels. The 3.8% estimate is higher than the 2.95% of 2017 but still lower than center-target, signaling no need to increase rates.

Election uncertainty will remain high, but is likely to recede in the next few months, as the recent trial of former-president Lula will take the market’s attention to the polls that consider him out of the race. Evidently, we will continue to monitor closely the news flow about the election and adjust this position in case uncertainty rises again.

We recommend receiving DI Jan21 at 8.78%. The trade enjoys a positive carry of 1.77% in annualized terms. For cash investors, we recommend receiving bonds with similar durations, such as the LTN July 2021.

The fiscal situation remains quite challenging, especially because social security reform has not yet been approved. However, the gross public debt dynamics is already set to stabilize in the short term because of stronger GDP growth, lower rates, and the anticipation of debt payments from BNDES local development bank to the National Treasury (see chart). Approval of social security reform in February (not our base case) would be good news, likely causing longer term rates (such as DI Jan27) to fall more than the belly of the curve.

 


 


MACRO TEAM:

Mario Mesquita - Chief  Economist
Fernando M Gonçalves, fernando.goncalves@itaubba.com
Luka Barbosa, lbarbosa@itaubba.com
Eduardo Alonso, eduardo.marza@itaubba.com



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