Chilean Investors Flock to CPI-Linked Notes on Oil Price Shock

pref[sqe]jnbpnccr)g7mok9_media_dl_5.png Bloomberg

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(Bloomberg) — Chile fixed income investors are wasting no time, plowing money into inflation-linked assets after the war in Iran triggered the biggest jump in gasoline prices at the pump since at least 1980.

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Almost 80% of the 23 analysts and traders polled by Bloomberg last week said they favor bonds denominated in Unidades de Fomento — an inflation-linked accounting unit — the highest percentage since October. Only five respondents said they would opt for peso bonds. 

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Chile’s government raised fuel prices by as much as 54% last week, a jump in costs that is expected to spread across the economy in the next few months. Bread, fruit and vegetable costs may be particularly vulnerable in the short term because of their limited storage potential. As a result, the central bank held off on an anticipated interest rate cut last week and raised its year-end inflation forecast to 4% from 3.2%.

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“Inflation-linked bonds tend to offer better protection of purchasing power than nominal bonds,” said Erick Martinez Magana, a strategist at Barclays in New York. “If oil prices remain high for an extended period, this could lead to higher inflation expectations.”

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The jump in fuel costs comes just as Chile seemed to be winning the battle against inflation. Consumer prices rose at an annual pace of 2.4% last month, the least since 2020. But that was before the Middle East conflict. 

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Nearly half of those surveyed now expect consumer price increases to rebound sharply, ending the year between 4% and 4.5%, above the central bank’s projection. One respondent sees inflation exceeding 5%.

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The Impact

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The impact of higher inflation forecasts on the market is clear to see.

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The yield on one-year peso bonds has spiked 25 basis points to 4.3% in March, the biggest monthly gain in almost a year. And as investors seek refuge in inflation-linked notes, the yield on similar duration UF bonds slumped 167 basis points to 0.98%. Rates on two-year UF bonds have dropped 125 basis points. 

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“Short-term investors are seeking greater exposure to the UF, which has been reflected in the difference between peso and UF yields,” said Ariel Nachari, strategist at SURA Investments. “Peso-denominated yields have seen the largest increases amid this search for inflation protection.” 

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The central bank doesn’t see inflation returning to its 3% target until 2027, suggesting the rate-cutting cycle has ended. Policymakers raised both the lower and upper bounds of their expected rate path on Wednesday, reinforcing this stance.

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“As long as the central bank maintains the monetary policy rate at this level, UF notes become even more attractive,” said Sebastian Ide, head of the trading desk at Banco de Chile.