Treasury bets on rate cuts to trim floating debt: Brazil credit

Brazil is planning to redeem bonds tied to the country’s benchmark interest rate at the fastest pace in seven years as the central bank’s decision to lower borrowing costs boosts demand for debt.

The redemptions may allow the government to reduce floating-rate obligations to less than 20 percent of total debt in 2014, down from 31.7 percent in September and 47.8 percent in 2004, Deputy Secretary Paulo Valle said in an interview. The Treasury plans to take advantage of this “opportunity” to boost its offering of fixed-rate benchmark bonds, or NTN-F, that are due in 2017 and in 2021, Valle said. Debt tied to Mexico’s interbank rate accounts for 18 percent of its total debt.

President Dilma Rousseff applauded policy makers after they unexpectedly cut the benchmark Selic rate by 50 basis points on Aug. 31, saying on Sept. 30 that Brazil couldn’t miss the opportunity provided by slower global growth to lower the highest borrowing costs in the Group of 20 nations. Yields on fixed-rate notes due in 2017 fell 23 basis points since Aug. 31 to 11.44 percent. The central bank trimmed rates again last month by a half-percentage point to 11.50 percent.

“The Treasury can do this principally because domestic investors want fixed-rate bonds,” said Marco Freire, chief investment officer for fixed-income at Franklin Templeton Investimentos, which manages $1 billion of assets in Brazil. “Investors have it in their heads that interest rates will fall.”

Yields on interest-rate futures contracts indicate traders are betting the central bank will lower the benchmark Selic rate by at least another 125 basis points, or 1.25 percentage points, by April.

‘Moderate’

Policy makers, led by central bank President Alexandre Tombini, reiterated yesterday that “moderate” interest-rate cuts amid slower growth in Europe, the U.S. and China will allow inflation to slow to Brazil’s 4.5 percent target next year from a six-year high of percent in 7.31 percent in September.

The Rousseff administration has pledged to contain spending in order to meet its target for the budget surplus before interest payments this year and provide policy makers with room to keep lowering borrowing costs in Latin America’s biggest economy.

“In a scenario in which interest rates fall faster and primary surpluses are stronger, it may be easier to reach an optimal composition for the debt,” Valle said in an Oct. 28 telephone interview from Brasilia. “It’s an opportunity to reduce the weight of the debt linked to Selic.”

Bond Tax

The government’s goal is to increase fixed-rate bonds to as much as 50 percent of total debt from 35.2 percent in September, according to the Treasury’s 2011 financing plan. Government bonds tied to the Selic account for 98 percent of the country’s floating-rate debt.

A 6 percent tax Finance Minister Guido Mantega put in place a year ago on foreigners’ purchases of local bonds may make it difficult for the Treasury to achieve its goal, said Diego Donadio, a Latin America strategist at Banco BNP Paribas Brasil SA. Foreigners and pension funds are the main buyers of fixed- income bonds, he said.

“It is too aggressive,” Donadio said in a telephone interview from Sao Paulo. “This reduction is very big and very fast, if you look at the history.”

The extra yield investors demand to own Brazilian government dollar bonds instead of U.S. Treasuries rose 11 basis points to 234 at 9:46 a.m. in Sao Paulo, according to JPMorgan Chase & Co.

Default Swaps

The real fell 2.2 percent to 1.7540 per dollar.

The cost of protecting Brazilian bonds against default for five years rose six basis points yesterday to 140, according to data provider CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market. Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a government or company fail to adhere to its debt agreements.

Brazil needs to reduce its reliance on floating-rate bonds to improve its credit quality, said Sebastian Briozzo, a director in the sovereign ratings group at Standard & Poor’s. The proportion of floating-rate debt in Brazil is higher than in its regional peers, he said.

The country is rated BBB- by S&P, the lowest investment grade.

Brazil’s decision to increase its share of fixed-rate bonds is “not the type of thing that by itself might lead to a change in the rating, but it’s definitely one of the things we are looking at when focusing on the fine tuning of Brazilian debt,” Briozzo said in a telephone interview from Buenos Aires.