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Goldman Vindicated as Swaps Traders Capitulate on Rates

Goldman Sachs’s Brazil Chairman Paulo Leme
Goldman Sachs’s Brazil Chairman Paulo Leme said developed nations face a “long and painful” deleveraging process that will weigh on global growth and provide room for Brazil to keep rates at record lows. Photographer: Dado Galdieri/Bloomberg

Swaps traders are capitulating to Goldman Sachs Group Inc. as bigger-than-forecast declines in wholesale prices prompts them to push out their bets on when the central bank will raise interest rates.

Traders who wagered in October that the bank would boost rates from a record low 7.25 percent as soon as April now predict there won’t be an increase before July. Policy makers cut the target rate for a 10th straight meeting on Oct. 10 and said they would keep the borrowing costs stable for a “sufficiently prolonged” period to revive the slowest growth among the biggest emerging-market economies.

While the largest rate cuts among Group of 20 nations has kept inflation above policy makers’ target of 4.5 percent for 26 months, the biggest decline in an index of producer prices in three years is supporting an Oct. 26 call by Goldman Sachs’s Brazil chairman Paulo Leme, who said the central bank won’t raise rates before 2014. Barclays Plc says lower producer prices will ease pressure on inflation as speculation increases President Dilma Rousseff’s government will turn to the exchange rate and fiscal policy to keep consumer prices in check.

“The new normal is low rates for a long period of time,” Marcelo Salomon, the New York-based co-chief of Latin American economics at Barclays, who like Leme expects stable rates to 2014, said in a telephone interview. “You do tax exemptions on the fiscal side instead of stimulating consumption and create an environment so you don’t need to hike rates in 2013. There’s less inflation pressure.”

‘Slower Recovery’

Goldman’s Leme, speaking at a Brazilian pension fund event in Sao Paulo on Oct. 26, said developed nations face a “long and painful” deleveraging process that will weigh on global growth and provide room for Brazil to keep rates at record lows.

“I’m more dovish,” Leme said. He didn’t respond to calls seeking further comment.

Banco Itau BB SA’s research team headed by chief economist Ilan Goldfajn cut their forecast for the 2013 year-end Selic rate to 7.25 percent in a monthly report e-mailed yesterday, from 8.5 percent in the same report the month before.

“We previously believed that with a steadier economic rebound, interest rates would bounce back in the second half of 2013,” the report said. “We now foresee a slower recovery.”

Keeping borrowing costs at record lows for a “prolonged time” is still the best strategy to ensure inflation will slow to the midpoint of the 2.5 percent to 6.5 percent target range in 2013, central bank President Alexandre Tombini said in an interview at his office in Brasilia on Nov. 7.

Stimulus Measures

The bank has cut its benchmark lending rate by 5.25 percentage points since August 2011 in a bid to stoke demand and bolster growth that economists surveyed by Bloomberg forecast to slow to 1.5 percent this year, from 2.7 percent in 2011 and 7.5 percent in 2010. The inflation-adjusted interest rate is still higher than every G-20 nation apart from China.

The government has also extended tax cuts for consumer and industrial goods, cut bank reserve requirements to boost lending, pressured banks to reduce profit margins on loans and increased public spending to stoke expansion.

The stimulus hasn’t taken hold in all parts of the economy. Industrial output in September fell 1 percent from a month earlier in the first drop in four months. Consumer default rates in September held at the highest level since November 2009.

Market Expectations

“The economy hasn’t recovered any more than was expected,” Carlos Kawall, the head of the economics department at Banco J. Safra, said in a phone interview from Sao Paulo. “The market should converge toward that expectation of a stable Selic. We’re seeing movement in that direction in the swap rates curve and the central bank survey.”

About 100 economists surveyed by the central bank forecast the economy will grow 1.54 percent this year and 4 percent in 2013. The same economists lowered their forecast for the 2013 year-end benchmark rate for the second straight week in the survey published Nov. 5 amid signs that the economy is struggling to gain speed after a year-long slowdown.

Brazil’s Selic rate will be 7.63 percent at the end of next year, according to the median estimate. Analysts had forecast 7.75 percent the previous week and 8 percent the week before that. The top five analysts in the survey cut their year-end 2013 forecast to 7.25 percent, from 7.5 percent the week before.

Inflation Outlook

Jankiel Santos, the chief economist at Banco Espirito Santo de Investimento in Sao Paulo, says the central bank will have to raise rates by October 2013 to control inflation that will reach 5.5 percent next year. Rousseff’s plan to force power companies to cut rates by as much as 28 percent, announced Sept. 11, won’t be enough to keep a lid on prices, according to Santos.

“We’re still worried about inflation,” Santos said in a phone interview. “Inflation won’t converge toward the target midpoint this year or even next year. With low unemployment and rising incomes, any price pressures from abroad will impact domestic prices.”

The extra yield investors demand to own Brazilian government dollar bonds instead of U.S. Treasuries fell two basis points, or 0.02 percentage point, to 147 basis points at 1:38 p.m. in Sao Paulo, according to JPMorgan Chase & Co.

The cost of protecting Brazilian bonds against default for five years increased two basis points to 104 basis points, according to prices compiled by Bloomberg. Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent if a borrower fails to adhere to its debt agreements.

The real weakened 0.5 percent to 2.0508 per dollar. Yields on interest-rate futures contracts due in January 2014 rose one basis point to 7.35 percent.

‘Hawkish Interpretation’

The Getulio Vargas Foundation’s IGP-DI price index decreased 0.31 percent in October from a month earlier, compared with a median forecast of a 0.15 percent slide among 31 analysts surveyed by Bloomberg.

The index is composed of 60 percent wholesale prices, 30 percent consumer prices and 10 percent construction costs.

The drop is a sign, along with Rousseff’s energy cost cuts, that consumer price increases will slow, according to Barclays’s Salomon.

Even if inflation approached the 6.5 percent upper end of the central bank’s target range, policy makers have other tools that they can use before raising rates, he said.

“The market still has too much of a hawkish interpretation about what can happen to rates,” Salomon said.

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