Opinion – From Grain to Grain: Market expects inflation to resume; see how to invest in fixed income

Rates traded on fixed income securities are a good thermometer for us to understand what investors are expecting. The recent movement of these rates signals that the relief in inflation was temporary and that it should accelerate again. The question resides in how the Central Bank will respond to the expectation of a resumption of inflation. I explain below how you can invest and protect yourself.

The table below shows the implicit inflation of Brazilian fixed income government bonds. It is constructed by calculating the difference in return between the rate of fixed-rate and IPCA-referenced securities.

According to the calculation, the expected inflation for the next 10 years should be 6.96% per year. In the next six months, price changes should be more significant, reaching 7.25% per year.

This means a resumption of inflation, as the expected IPCA for the second half of 2022 is just 0.4% for the entire half. This semester, we experienced one of the biggest deflations of the last two decades. But, it was an isolated and non-recurring event. Anyone who thinks prices will remain low is fooled.

Many who invest in securities referenced to the IPCA were already switching to other indexes with the fear that deflation would persist. If you haven’t traded, wait.

We have to follow the next movements of the Selic rate by the Central Bank.

The market prices that the Monetary Policy Committee (Copom) should raise interest rates by at least another 0.75% in the next four meetings.

That expectation has changed in recent weeks with fears of increased government spending. This can be seen in the sharp rise in interest rates shown in the chart below.

If this increase in interest rates does not occur, securities linked to the IPCA become interesting in the short term and even more advantageous in the long term.

If the Central Bank resumes the cycle of interest rate hikes, then the choice of index to invest in depends on the investment horizon.

If the Copom raises interest rates as expected, Selic-linked securities remain a good option for investment horizons of up to 24 months.

For the long term, real interest rates, that is, above inflation, are interesting.

In both situations, private bonds that pay a premium over government bonds are even more attractive.

The next Copom meeting will be on December 8th. Let’s follow this thermometer.

Now, comment here if you think inflation will be higher or lower than what the market expects.

Michael Viriato is an investment advisor and founding partner of Investor House

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