Chile Investors Seek Shelter in CPI-Linked Notes Amid Oil Price Volatility Shock

Chile's Investors Rush to Inflation-Linked Assets After Fuel Price Shock

Chile's fixed income investors are rapidly shifting their focus to inflation-linked assets, driven by the biggest jump in gasoline prices at the pump since 1980, triggered by the war in Iran. According to a Bloomberg survey of 23 analysts and traders, nearly 80% of respondents favor bonds denominated in Unidades de Fomento (UF), an inflation-linked accounting unit, the highest percentage since October. Only five respondents opted for peso bonds.

The Chilean government raised fuel prices by up to 54% last week, a significant increase in costs that is expected to spread across the economy in the coming months. As a result, the central bank held off on an anticipated interest rate cut and raised its year-end inflation forecast to 4% from 3.2%. With inflation-linked bonds offering better protection of purchasing power than nominal bonds, investors are seeking refuge in UF notes.

The jump in fuel costs comes at a time when 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. However, the Middle East conflict has led to a sharp increase in inflation expectations, with nearly half of those surveyed expecting consumer price increases to rebound sharply, ending the year between 4% and 4.5%, above the central bank's projection.

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The impact of higher inflation forecasts on the Chilean market is clear. 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. In contrast, the yield on similar duration UF bonds has slumped 167 basis points to 0.98%. Rates on two-year UF bonds have dropped 125 basis points.

The central bank's stance on monetary policy has also been reinforced, with policymakers raising both the lower and upper bounds of their expected rate path. This suggests that the rate-cutting cycle has ended, and UF notes have become even more attractive.

The energy shock may not be over, with crude oil prices climbing above $110 a barrel on Friday. The external geopolitical environment is expected to be the main driver for local rates in April, with over 80% of respondents citing this as the key factor. At home, truckers have left open the possibility of protests, which could further exacerbate the situation.

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Investors are recommending being overweight in the three to five-year portion of the UF curve, where opportunities in terms of risk and return are seen as greatest. With inflation expectations on the rise, investment opportunities in long positions in inflation breakevens, which are a measure of consumer price expectations, are being recommended.