Brazil and Chile Traders Call for Bolder, Faster Rate Hikes

(Bloomberg) -- Traders in Chile and Brazil stepped up their rate hike bets amid a surge in U.S. yields, demanding central banks to be bolder and faster in fighting rising inflation expectations.

Swap rates in both countries, which were already anticipating rate hikes this year, rose further last week amid reflation trade bets and a rally in copper and oil prices. Now, curves are pricing in aggressive monetary tightening cycles, way beyond what economists forecast and central banks have been signaling.

In Brazil, traders are expecting a half-percentage point hike not only this month but in each of the remaining meetings of the year -- a bet that a former central bank director called an exaggeration. In Chile, rate hike bets for the next two years more than doubled even as the central bank has said it will likely remain on hold for much of the period.

Brazil and Chile central banks will probably “lead the way” in monetary policy normalization in emerging markets, Natwest Markets strategists led by Alvaro Vivanco wrote in a Monday note.

Latin American yields followed the spike in U.S. Treasuries that sent emerging-market currencies crumbling last week. Chile's two-year Camara swap rate jumped 14 basis points, extending last month's advance to 42bps. This has led the curve to imply 60bps in rate hikes this year, double what was expected by the end of last year, and 120bps in 2022, from 50bps two months ago.

The same happened in Brazil, where the January 2022 DI rate climbed 32bps last week and 45bps in a month. Traders now expect a half-percentage point rate increase on March 17 to be followed by six other hikes of same magnitude, taking the benchmark rate from a record low of 2% to 5.5% by the end of the year. A few weeks ago, traders were still split between a 25bps and a 50bps move this month.

The priced in moves in both countries contrast with what central banks have been signaling. Chilean policymakers have indicated rates will remain on hold as the recent pick up in inflation is “temporary.” Still, the nation's five-year breakeven inflation more than doubled over the past six months amid a surge in copper prices and expectation the economy may grow at the fastest pace in a decade. The last time the inflation breakeven was above 3%, interest rates were triple the current level.

In Brazil, inflation expectations are rising amid heightened fiscal concern as the government is expected to deliver another round of emergency aid payments to informal workers. The one-year inflation breakeven rose to 5.2% in February from 4.6% in the previous month, reaching the upper bound of the central bank's target range that goes from 2.25% to 5.25%.

While the central bank has signaled a tightening cycle would start this year, traders are ahead of economists in the weekly central bank survey, who have raised their inflation forecast for this year to 3.87% from 3.3% in December. They see rates reaching 4% by the end of the year and 5% in 2022.

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