Jan. 28 (Bloomberg) -- Brazilian local bond yields will plunge this year because traders are overestimating interest- rate increases in Latin America’s biggest economy, Bank of America Corp. and Pacific Investment Management Co. said. While central bankers indicated yesterday that they may be moving toward the first rate rise since April 2008 to tame inflation, Bank of America Corp.’s Daniel Tenengauzer and Pimco’s Guillermo Osses say the increases will be smaller than investors expect as the economic recovery picks up. “The amount of tightening that is priced in the curve is more than what we think we’ll get,” Osses, who helps oversee $50 billion in emerging-market assets at Pimco, the world’s biggest bond fund, said in a phone interview. “We’re positive on the Brazilian local bond market.” The yield on Brazil’s 10 percent notes due in 2012 will slide 50 basis points, or 0.5 percentage point, this year to about 11.3 percent, which would be the lowest since September, according to Osses. Tenengauzer, the head of emerging-market fixed-income strategy at Bank of America, predicts yields on the country’s 10 percent bonds due in 2017 will tumble 90 basis points to about 12.3 percent, the lowest since June. Yields have dropped since reaching a 10-month high in December as investors began to pare bets on rate increases. Brazil’s most-traded interest-rate future contract -- for January 2011 delivery -- indicates traders expect the central bank will raise the benchmark overnight rate to about 12.6 percent by year-end from a record 8.75 percent. Inflation “For a country like Brazil that has a good record of well- behaved inflation, nominal yields should be lower,” Tenengauzer said in a phone interview from New York. Annual inflation, as measured by the government’s benchmark IPCA index, was 4.3 percent in December, below the government’s 4.5 percent target. Economists predict inflation will quicken to 4.6 percent by December, according to the median forecast in a central bank survey published Jan. 25. The central bank, led by President Henrique Meirelles, held the benchmark rate at 8.75 percent for a fourth straight meeting late yesterday, in line with forecasts from all 43 economists surveyed by Bloomberg. Policy makers said in a statement that they would follow the economy’s evolution until their next meeting in March to then “define the next steps in its monetary policy strategy.” They removed language saying the current rate was adequate to contain inflation, a sign that they may be leaning toward raising borrowing costs as soon as April, according to Roberto Padovani, senior strategist at WestLB do Brasil in Sao Paulo. Bonds Outperforming “The statement signals the central bank will increase rates soon,” Padovani said. Bank of America predicts policy makers will increase the overnight rate to 10.5 percent this year, less than the 12.6 percent rate forecast by futures traders and below the 11.25 percent median forecast in the central bank’s survey of economists. Osses declined to provide a specific year-end benchmark rate forecast. The unhedged return on Brazil’s local debt is 0.4 percent this year, following an 11 percent return in 2009, according to JPMorgan Chase & Co. indexes. Local-currency debt in Latin America overall has returned 0.3 percent this year after posting a 10 percent gain in 2009, according to JPMorgan. The yield on Brazil’s 80.45 billion reais ($43.3 billion) of 10 percent bonds due in 2012 has dropped 20 basis points since Dec. 17 to 11.81 percent, according to Bloomberg. Yields had surged from 10.72 percent in June as Brazil’s economy emerged from its first recession since 2003, fueling concern inflation was poised to accelerate. ‘Major’ Asian Demand The average yield on Brazil’s real-denominated Treasury bonds may drop to as low as 8 percent from 12.2 percent in “the medium term,” Tenengauzer said. Part of the demand will come from Asia, where Brazil’s local bonds are a “major attraction” among investors, he said in a research note last week after visiting the region. Brazil’s local bond yields will fall in the next three to five years to levels similar to those of Poland and Mexico, according to Osses. Mexico’s local bonds maturing between 2010 and 2038 yield from 4.87 percent to 8.64 percent, according to Bloomberg data. “Investors are looking more favorably on holding Brazilian bonds,” Tenengauzer said.