What do the Yield Curves Say?
In the past four weeks, the nominal yield curve (based on the DI rate) has shifted steadily upward. That movement can be partly attributed to the continuous upward shift of the real yield curve, combined with the same upward movement of the implicit inflation rates. We attribute the rising real interest rates to the continuous increase of the risk premium, due to the general recognition of the fragility of the fiscal framework and the corresponding worse sustainability of the public debt.
Since the government faces a daunting hurdle to obtain the needed additional revenue, it will be virtually impossible to meet the primary result targets, so the debt/GDP ratio should increase to around 86% at the end of the Lula government. We attribute the positive slope and upward shifts of the implicit inflation curve to the reduced confidence in the Central Bank’s ability to achieve the inflation target.
Not only does the Central Bank have to overcome the effects of the expansionary fiscal policy, which raises the neutral interest rate and expands aggregate demand, reducing the power of restrictive monetary policy, it also is suffering the effects of the rising neutral interest rate in the United States, which is acting indirectly through the Brazil-USA real interest rate parity to limit the space for the Central Bank to lower the SELIC rate. In our view, unless the Central Bank decides to work with an implicit rate above the central target, it will be unlikely for the SELIC rate to reach 8.5% at the end of the easing cycle as reflected in the Focus survey.
To re-anchor expectations in 2025 and 2026, the Central Bank will have to send a hawkish message to the market and stick to that intention, with the SELIC rate ending the cycle at 10.5%.
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