In Brazil, Barclays Defies Trader Wisdom by Predicting Rate Cuts

  • Swaps market shows borrowing costs will start rising next year
  • `Brazil has lost any sense of future' -- Gradual's Perfeito

Like most economists, Barclays Plc’s Bruno Rovai expects the recession in Brazil to grow so dire next year that the central bank will have little choice but to start cutting interest rates.

Traders are signaling that he couldn’t be more wrong.

With inflation running at close to 10 percent, the swaps market is pricing in the likelihood that the nation’s benchmark rate will rise at least a percentage point in 2016. That would push borrowing costs above 15 percent for the first time since 2006. And economists surveyed by the central bank have repeatedly overestimated the monetary authority’s ability to get inflation under control, even as persistent price pressures compelled policy makers to almost double rates from a low of 7.25 percent in 2013.

Rovai is confident things will turn out differently this time. With Brazil’s political crisis deepening the paralysis in government and spurring a push to impeach President Dilma Rousseff, economists like Rovai are increasingly coming to the view that the central bank will need to be more aggressive in pulling the country out of its quagmire.

"The combination of a weaker economy and stronger disinflation will create conditions for interest-rate cuts," he said. "That’s what we consider to be the most likely scenario."

For now, traders and analysts agree the key rate will remain unchanged for third straight meeting on Wednesday. The median economist estimate calls for borrowing costs to drop by a half percentage point to 13.75 percent by the end of next year. Rovai himself says the central bank will start dropping rates in August.

The central bank hasn’t cut rates since 2012 and a reduction would put Latin America’s largest economy in the company of other emerging markets such as Russia and China that have eased monetary policy to shore up growth. Analysts in a Bloomberg survey predict Brazil’s economy will contract 3 percent this year and 1.2 percent in 2016.

Any monetary easing also would be an about-face for Brazil’s central bank after it increased rates five times both this year and last. The increases haven’t yet succeeded in containing consumer prices or bringing inflation expectations to the official target of 4.5 percent. The bond market’s inflation outlook over two years has surged 2.2 percentage points since August to 9.38 percent.

Political Stalemate

The political crisis has entered a stalemate since the end of August, and most Brazilians expect the turmoil to drag on for years. The government’s approval rating remains stuck at record lows, and the lower house speaker hasn’t decided whether to accept requests to start impeachment hearings against the president. Legislators can’t agree whether to pass government legislation that’s designed to close the budget gap, putting the country at risk of a third credit-rating downgrade in less than a year.

Traders and analysts read the turmoil differently, said Andre Perfeito, chief economist at Sao Paulo-based brokerage Gradual Cctvm. The former view the threat of further credit cuts as reason to expect higher rates, while analysts are concerned that fiscal uncertainties will push Brazil deeper into recession, he said.

The central bank board hasn’t explicitly signaled what direction it will take on monetary policy, and its press office declined to comment for this article.

“Brazil has lost any sense of future,” Perfeito said. "That undermines the central bank’s efforts to coordinate market expectations."

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