High interest rates in Brazil fuel the best global carry trade

Bloomberg — The rally in the Brazilian real is gathering steam as skyrocketing commodity export prices and one of the world’s highest interest rates fuel a lucrative carry trade for investors.

Rapidly rising rates and the best commodity price performance in 30 years fueled a great start to the year. The carry trade (what investors earn by borrowing in dollars and buying local notes) has produced a return of 24% since the end of December, the most worldwide and more than double the profit of the country that follows it on the list.

It’s a drastic turnaround for a currency that has weakened in each of the last five years, having fallen 40% against the dollar in that period as the economy stalled and foreign investment dried up.. Now with analysts betting that a favorable political outlook and higher demand for oil, soybeans and iron ore are boosting Brazil’s export record, the real extends its biggest quarterly gain since 2009.

Gains in Brazil are a respite for global investors hit by losses in most other markets this year.from US stocks to government bonds and corporate credit.

“Where else can the money go?” said Danny Fang, a strategist at Banco Bilbao Vizcaya Argentaria SA (BBVA) in New York. The bank was among the top forecasters of the real in the first quarter, according to rankings from Bloomberg.

The real has strengthened 21% this year to a two-year high near 4.6 per dollar, buoyed by the central bank’s aggressive monetary tightening to combat inflation. With the exception of Russia, no other country in the world raised rates as much as Brazil over the past year.. The benchmark rate is up 9.75 percentage points and may rise another full point next month before officials finalize the hike cycle.

With interest rates expected to remain elevated until at least the end of the year amid persistently above-target inflation, the real is likely to remain one of currency traders’ favorite currencies. carry trade. Despite rising borrowing costs globally, Brazil’s interest rate differential with respect to the US exceeds 11 percentage points; it is 10 points above the Asian average and 5 points above the Latin American average.

“Brazilian bonds and the real are quite far removed from the emerging markets pack,” Joana Freire, a fund manager at Eurizon Capital in London, wrote in a report last month.

Brazil’s 10-year local currency bond yield has risen some 450 basis points since the beginning of 2021 to 11.3%, second highest among major developing economies, behind only Russia.. It’s also about five times the equivalent Treasury rate, even after the US bond market experienced its most brutal quarter in modern times on expectations of tighter Federal Reserve policy.

The yield on Brazil's 10-year local bonds is five times narrower than equivalent US Treasury instruments.

Brazilian assets also offer the benefit of being away from the Ukraine war. Unlike many developing nations in Europe, Brazil does not have strong trade ties with Russia and is expected to be less affected by the conflict. and economic sanctions.

The Latin American nation is also benefiting from the commodity boom triggered by global supply shocks caused by the war. Commodities, including iron ore, crude oil, soybeans and sugar, account for about 70% of the nation’s exports, and prices have jumped. The 25% gain from the commodity index of Bloomberg the last quarter was the highest since 1990.

All this has attracted a wave of dollars to the country. Non-residents have cut their bearish bets on the real against the dollar by US$5.1 billion since March 14according to local stock market data compiled by Bloomberg.

While rising interest rates are usually bad for stocks, that hasn’t been the case in Brazil, where the Ibovespa index is up 39% in dollar terms since the start of the year, the biggest gain among 92 stock market indices. reference followed by Bloomberg. Foreign investors added about 64.1 billion reais ($13.9 billion) in that period, the most for any quarter since at least 2008..

Now, the real is stronger than the most bullish projection compiled by Bloombergand the median estimate now predicts a 14% loss by the end of the year. Bears see a rocky road ahead for the currency amid potential political turmoil and government overspending tied to this year’s presidential election..

But investors believe that concern would be exaggerated. They have been feeling more comfortable with favored candidate Luiz Inácio Lula da Silva, President Jair Bolsonaro’s main challenger, who is seeking re-election.. The idea is that whoever wins the election will follow policies that will boost the economy.

“The fundamental catalysts are still there: high carry tradelocal assets look cheap, political/fiscal risks seem contained in the short term”said Juan Prada, a New York-based currency strategist at Barclays Capital Inc. (BCS), which provided the most accurate forecasts for the real in the first quarter, according to Bloomberg ratings. “The momentum is still strong, although the speed of the rally surprised me.”

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