Brazilian Swap Rates Surge Amid Rising Inflation Concerns and Fiscal Skepticism

Key Takeaway

• Brazilian swap rates now imply a 65 basis point rate hike to 11.15% by year-end, diverging from the central bank's dovish stance.
• Rising inflation concerns, with two-year breakevens at 4.85%, are driving market skepticism about Brazil's fiscal discipline.
• Finance Minister Haddad's comments on fiscal targets have further fueled market volatility, causing significant jumps in swap contracts maturing in 2025 and 2027.

Swap Rates Surge

Mounting skepticism over Brazil’s ability to control its fiscal deficit has led to significant shifts in the country's swap rates market. Swaps have now priced out any chance of further interest rate cuts, implying a 65 basis point increase in the key rate to 11.15% by year-end. This is in stark contrast to the central bank's stance, which has left the door open to cutting borrowing costs in its upcoming meeting. Economists, on the other hand, expect the Selic rate to fall to 10.25% by the end of the year.

The Brazilian swaps market has experienced severe shifts in just a few days. For instance, the contract maturing in January 2025, one of the shortest-dated ones, surged 30 basis points in five sessions. To put this in perspective, Mexico’s one-to-six month TIIE swaps have risen only 12 basis points since the surprise election results roiled the market.

Inflation Concerns

There are legitimate reasons behind the move in swap rates. Brazil’s two-year inflation breakevens have risen to 4.85%, significantly above the central bank’s 2-4% inflation target for the next few years. Key central bank officials, including Governor Roberto Campos Neto, have highlighted the deanchoring of inflation expectations as a challenge, with special emphasis on 2025.

Concerns escalated further on Friday after a closed-door meeting between Finance Minister Fernando Haddad and representatives of local financial institutions. Attendees left with the impression that the government would not be able to meet its fiscal target and would likely move to change the fiscal framework approved in 2023. Haddad attempted to mitigate the impact of his comments by stating he was misinterpreted, but the damage was already done — contracts due in 2025 jumped more than 20 basis points, and those maturing in 2027 soared 60 basis points.

Market Reactions

“It is now abundantly clear that the new fiscal framework failed as a fiscal anchor, and that the administration shows no inclination to control spending,” said Alberto Ramos, chief Latin America economist at Goldman Sachs. “Given this backdrop, there is some probability that things will get unhinged and force the central bank to hike rates,” he added, making clear that the odds of that happening are still low.

The market's reaction underscores the growing skepticism among investors regarding Brazil's fiscal discipline. The sudden shifts in swap rates reflect a broader concern about the country's economic stability and the government's ability to manage its fiscal policies effectively.

Street Views

• Alberto Ramos, Goldman Sachs (Bearish on Brazil's fiscal policy):

  "It is now abundantly clear that the new fiscal framework failed as a fiscal anchor, and that the administration shows no inclination to control spending. Given this backdrop, there is some probability that things will get unhinged and force the central bank to hike rates."