Brazil Leads the Bets Against Hawkish Central Banks

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Bloomberg — Brazil might be the only place in Latin America where traders are right to defy a hawkish turn from policy makers, according to at least three leading banks.

While swap markets across the region are pricing in rate cuts next year, analysts from Goldman Sachs International, JPMorgan Chase & Co. and Citigroup Inc. say Brazil is the sole country where holding receivers -- positions that profit from falling rates -- may actually pay off.

Brazil’s swap rates are on a downward trend as inflation slows, with the worst of the spike in consumer prices likely over. The nation’s main inflation gauge slowed for a second month in August and most economists think it will continue to ease, partially due to fuel tax cuts. The country’s swap rates curve currently prices in more than 270 basis points in rate cuts next year, partially unraveling the 11.75 percentage-point tightening deployed by the central bank since early 2021.

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Brazil’s swap rates rose after the central bank sent a hawkish message to investors, reminding them that a final interest rate increase remains on the table even as most traders bet that its aggressive monetary tightening campaign ended last month

“Given the hawkishness out of the Fed and ECB, receivers in EM have to remain quite selective,” Citigroup Inc. analysts including Dirk Willer and Andrea Kiguel wrote in a client report on Thursday.

Citi has been telling clients to receive Brazil’s swap rates due January 2025 since early August. Their view is that it’s worth staying overweight Brazil duration despite any risks associated with next month’s presidential election.

JP Morgan Chase & Co. also cites Brazil as the only country in Latin America to receive rates. They like the January 2026 receivers “on slower economic activity, downside inflation surprises, appealing valuations and high real rates,” according to a note from Saad Siddiqui and Gisela Brant published in August.

Banks across the region have turned more hawkish. Chile delivered a larger-than-expected hike last week amid highest inflation in three decades, while Brazil’s central bank chief said policy makers aren’t thinking about rate cuts yet as the Federal Reserve reiterated its resolve to curb price gains.

The outlook for any rate cuts in Colombia next year also darkened after inflation accelerated more than forecast in August, with prices rising at the fastest pace since 1999.

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Still, traders are pricing a deceleration of the tightening pace in Mexico and Chile in the next quarter and an end to the hiking cycle in Brazil. For next year, local swap rates price in more than 250 basis points in easing in Chile and more moderate rate cuts in Mexico and Colombia. The Fed funds market pencils in less than a 25 basis points reduction in 2023.

Analysts from Barclays and RBC Capital Markets are betting on rate cuts in other countries in the region, not just Brazil. Lewis Jones, a portfolio manager at William Blair, said he likes receiving rates in Colombia and Peru as well.

“Inflation will start to fall quickly and those offer the most attractive term premium and value relative to global rates,” he said, adding Brazil is still his top pick to bet for rate cuts.

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Yet Goldman Sachs International strategists including Kamakshya Trivedi and Davide Crosilla told clients to be careful when betting on lower rates in emerging markets. Just like Citi, they recommend receiving Brazil’s January 2025 rates.