Itaú BBA - Receive the very front-end of local rates in Brazil – Local Rates Trade Idea

Latam FI Strategy Monthly

< Back

Receive the very front-end of local rates in Brazil – Local Rates Trade Idea

June 18, 2018

We believe BCB will keep the Selic rate stable this week

We believe BCB will keep the Selic rate stable this week, and therefore recommend receiving the DI October 2018 at 6.82%. We also recommend a small short BRL position to hedge against a strong currency depreciation that could cause BCB to hike.

We have been out of Brazil’s local rates since April 2018 because of increasing domestic and global risks. Now we believe there is an opportunity in the very front-end of the curve, because the market has priced in a tightening cycle, and our base case is that BCB will keep the policy rate stable at 6.50% until the end of this year. The October 2018 DI rate stands at 6.82%, while the spot DI rate stands at 6.39% (see chart). This pricing implies around 110bps in rate hikes in the 3 next Copom meetings.

Brazil has low external vulnerability, especially because of high international reserves, low foreign public debt, and a small current account deficit, which in our view allows policy makers to separate FX policy from monetary policy and emphasize the inflation targeting regime. In fact, BCB has been intervening in the FX market through swaps, and the COPOM has highlighted that monetary policy will not react automatically to the exchange rate dynamics.

According to our calculations, with the BRL between 3.70 and 3.80, the central bank will most likely be forecasting inflation still below the target for 2019, indicating no need to hike rates. In other words, significant further depreciation is required for inflation to be forecasted above the target in 2019 (link), so that the central bank could have a reason to raise rates.

The risk for further depreciation exists, especially given the strengthening trend of the USD against all EMs and domestic risks. Therefore, we also recommend a small short BRL/USD position to hedge against a strong depreciation that would cause BCB to deliver the hikes priced in the curve. Our value invested in the short BRL position is only 1.4% of the value invested in local rates.



< Back