The Macroeconomic Determinants of the Term Structure of Inflation Expectations in Brazil

Abstract

This paper aims to analyze the dynamics of inflation expectations according to macroeconomics conditions. To this end, we extract the expected inflation curve implied by indexed bonds and then estimate a dynamic factor model. The factors corresponds to the level, slope and curvature of the term structure, varying over time as a function of the exchange rate, inflation, commodities index and the CDS-implied Brazil risk. A one standard deviation shock to the exchange rate increases inflation more in the short and long ends of term structure than in the medium run. The same pattern arises after a shock to inflation. A shock to commodity prices increases inflation mostly in the short term, stabilizing at a higher level than the original curve. In contrast, a shock to the CDS shifts down the expected inflation curve in a virtually parallel manner.

What Drives the Nominal Yield Curve in Brazil?

“…In fact, this is the same motivation of previous works using Huse's (2011) model to estimate term structures in Brazil. In particular, Thiele and Fernandes (2015) investigate how the term structure of inflation expectations varies with observable macroeconomic variables, whereas Fernandes, Munhoz, and Nunes (2021) focus on the USD-denominated yield curve in Brazil.…”