March. 3 (Bloomberg) -- Brazil's real fell the most in nine months, the biggest fluctuation of any currency today, on speculation that the country's yield advantage will shrink.

The spread between the Brazil's 10-year bond and the U.S. Treasury note of similar maturity narrowed to a two-month low as the security gained for a third day. The gap may close further should a U.S. employment report tomorrow show the U.S. added jobs at the fastest pace since October, said Doug Smith, chief Americas economist at Standard Chartered Bank in New York.

``It's Brazil whose spreads will tighten the most, and that affects the currency and the bonds,'' Smith said.

The real fell 1.6 percent to a six-week low of 2.6865 per dollar at 2:05 p.m. New York time from 2.6390 per dollar late yesterday, the worst performance against the dollar among the 16 major currencies.

Higher interest rates in the U.S. may reduce the difference between returns on lower-risk U.S. debt and higher-risk Brazilian debt, lowering demand for investments in South America's biggest economy. Investors demand 3.5 percentage points extra yield for Brazil's 10.5 percent bond due 2014 over a comparable maturity U.S. Treasury.

Bonds Rise

Brazil's benchmark bond maturing in 2040 rose 0.45 cent on the dollar to 116.15, paring its yield to 9.46 percent, according to JPMorgan Chase & Co. The bond has doubled in price since President Luiz Inacio Lula da Silva took office in January 2003 as his government narrowed the budget deficit and curbed inflation.

The economy grew at its fastest pace in a decade last year, at 5.2 percent, led by rising exports and increased consumer demand.

``Everything is going great for Brazil,'' said Dario Pedrajo, who manages $400 million in emerging-market securities at Biscayne Americas Advisors in Miami, including Brazilian bonds.

The currency extended its decline after the central bank said it plans to reduce its bet to zero that the real will rise against the dollar and that it will continue to buy dollars to boost its foreign reserves.

The central bank on Feb. 2 began to auction the swaps, which pay investors if the real strengthens, in a bid to stem its appreciation to a 32-month high of 2.5525 per dollar on Feb. 18. The swaps allow investors to benefit from the yield advantage offered by Brazilian investments without adding to inflows and extending the real's gains.

Contracts

In recent years the central bank has sold contracts to protect against declines in the real. It has recently sold contracts to guard against appreciation of the real to limit the currency's gain and offer exporters a way to guard against the impact.

``The central bank has made it clear that it is going to keep buying dollars for reserves and end its bet the dollar will weaken against the real,'' said Joao Medeiros, a partner at Pioneer Corretora de Cambio in Sao Paulo.

The central bank has been buying dollars on a daily basis since Dec. 6. As of March 1, the bank had accumulated $60.16 billion, up from $54.23 billion a month earlier.

``The central bank has bought a lot of dollars, as we've been able to see with the most recent figures and lately it is also willing to buy dollars at higher prices, which is affecting the exchange rate,'' said Flavio Farah, head of the Treasury desk at the Sao Paulo unit of German bank WestLB AG. ``The bank has been very aggressive on purchases.''

To contact the reporter on this story: Robert Jameson at rjameson@Bloomberg.net

Last Updated: March 3, 2005 14:32 EST