Market already includes 6.5% inflation in fixed rate bonds

With the new high of the Selic rate promoted last week by the BC (Central Bank), to 13.25% per year, investments in the fixed income class gain even more attractiveness.

It is not just the rise in the basic interest rate, however, that has contributed to the increasingly generous returns to fixed-income investors.

Current high levels of inflation, and the market’s expectation that it will remain under pressure for some time to come, also weigh in favor of the double-digit interest rates offered by fixed-rate government bonds.

On the Tesouro Direto digital platform, in which the government offers individual investors the negotiation of public securities, fixed-rate securities maturing in 2025 offered a nominal return rate of 12.58% this Monday (20th). In the case of bonds for 2029, the yield rose to 12.69%, and to 12.81%, among those maturing in 2033.

According to Felipe Beckel, chief fixed income strategist at brokerage Necton, inflation that market agents project for the coming years is embedded in bond rates.

Beckel says that this implied inflation, according to market jargon, is currently around 6.5% for 2023, reaching even slightly higher levels, close to 6.7%, for the longer vertices, from 2025 onwards.

“The implied inflation in bonds clearly shows that the BC has lost the anchoring of inflation expectations not only for this year and next year, but for the medium and long term as well”, says the chief fixed income strategist at Necton.

“I don’t remember seeing such high implied inflation in the last ten years in the medium and long term in the local market”, adds Beckel, also remembering that, over the past week, on days of increased investor nervousness, rates of implied inflation came close to 7.7%.

Founding partner and manager of SF2 Investimentos, Sergio Machado says that inflation is high not only in Brazil, but in several other countries, such as the United States and large European economies, together with a series of uncertainties on the horizon, with high interest rates in developed markets, the risk of global recession, the Ukrainian War and elections in Brazil, contribute to the inflation implied in bonds being at current levels.

That’s because, as the uncertainties on the radar of investors increase, the premium demanded by the market in the purchase of bonds also tends to increase, explains the expert.

“This month, we are having an escalation of concerns about the behavior of future inflation”, says Machado.

The manager of SF2 Investimentos says that the fact that the Central Bank took the basic interest rate to unsustainable levels of 2% per year in 2020, and, even more than that, kept it at such low levels for a relatively short period of time. In the long run, it has also contributed to the de-anchoring of inflation expectations by market agents.

“The BC lowered the interest rate too much, and then it had to run behind the curve, as the BCs around the world are running. This generates great instability”, says Machado, adding that the extremely polarized election in Brazil also began to into analysts’ accounts in recent weeks, putting additional pressure on an already turbulent environment.

Operator of the management team at MAG Investimentos, Ricardo Jorge also recalls that, in the latest BC communiqués released at the end of Copom (Monetary Policy Committee) meetings, the authority indicated that the increases promoted in the Selic rate would be sufficient to bring inflation down more relevantly.

And, although a series of factors that are beyond the control of the BC have weighed on inflation to remain under pressure, the fact is that the credibility of the monetary authority ends up being harmed, resulting in the high level of inflation projected by the market, says the expert.

Managers forecast outstanding fixed rate returns in the coming months

Beckel, from Necton, calculates that a break-even inflation of around 5% to 5.5% would be a level more consistent with the macroeconomic scenario expected ahead, from a medium and long-term perspective. And, even because of this distortion prevailing in the market, the chief fixed income strategist at Necton believes that there is at this moment a good opportunity for investors to take advantage of the rich rates offered by fixed-rate bonds.

Chief strategist at Renascença DTVM, Sergio Goldenstein, also assesses that fixed-rate bonds tend to perform better than their peers over the next few months. “As implied inflation is very high, the perspective is that from now on the fixed rates will have a better yield than the real interest rates of NTN-Bs”, says the expert.

The chief strategist at Renascença also says that, at times when current inflation is very high, as it is now, it is common for the market in general to extrapolate the perspective that it will remain at very high levels for a long time.

He notes that the implied inflation of around 6.5% to 6.7% along the vertices of the fixed interest rate curve is well above the BC inflation target, and that the tendency is for some accommodation of these rates a little more forward. Goldenstein estimates that an implied inflation closer to 4.5% would be a level considered more balanced from a medium and long-term perspective.