Most Profitable Carry Trade Spurred by Colombia’s Interest-Rate Increases

Betting on gains in the Colombian peso has proven to be the most profitable risk-adjusted trade in the foreign-exchange market this year as policy makers raise interest rates to keep inflation in check.

The peso’s so-called Sharpe ratio, a gauge that measures the reward for the risk investors take, jumped to 22 this year, the highest among 44 currencies tracked by Bloomberg. The peso’s drop in volatility is making it more appealing to investors who buy higher-yielding currencies with funds borrowed in countries with lower interest rates.

Further rate increases in Colombia, the region’s only major economy to be tightening monetary policy, will drive gains in the peso, said Flavia Cattan-Naslausky, a strategist at RBS Securities Inc. in Stamford, Connecticut. Most economists surveyed by the central bank for a report published Jan. 12 forecast policy makers would keep the key lending rate at 4.75 percent at their meeting on Jan. 30, before raising it a quarter point to 5 percent in February and to 5.5 percent by year-end.

Colombia definitely is at the other extreme, being one of the few central banks that are hiking,” Cattan-Naslausky said. “That reinforces the attractiveness of this trade where you have resiliency in terms of growth, where you have a very conservative central bank and you still have very good flows.”

Rate Outlook

The peso rose for a fourth consecutive week, closing today at 1,807.03 per U.S. dollar. It has jumped 7.3 percent this year.

Policy makers last increased Colombia’s key rate a quarter percentage point in November, citing “very dynamic” internal demand, loan growth and record housing costs. The rate was at a record low of 3 percent in January 2011.

Colombia’s rate increases are in contrast to cuts in emerging markets worldwide. Brazil, Chile, Russia, the Philippines, Israel, Romania, Moldova, and Mauritius all reduced benchmark lending rates within the past two months amid concerns Europe’s debt crisis will derail global growth.

Banco de la Republica will lift the overnight lending rate to 5 percent in February and leave it at that level through the remainder of the year to keep inflation below 4 percent, the upper limit of the target range, predicts Camilo Perez, the head analyst at Banco de Bogota SA, the country’s second-biggest bank.

“The economy doesn’t need further stimulus,” Perez said.

Colombia’s gross domestic product rose 7.7 percent in the third quarter from a year ago, the fastest pace since the fourth quarter of 2006. It may have grown as much as 6 percent in 2011, the fastest pace since 2007, according to the central bank.

Inflation Target

Latin America’s fifth-largest economy will grow 4.5 percent this year, more than the region’s 3.7 percent estimated average, the United Nations Economic Commission for Latin America predicts.

Inflation (COCPIYOY) ended 2011 at 3.73 percent, within the central bank’s target for this year and next of 2 percent to 4 percent.

The jump in GDP, as well as gains in the peso, are being spurred in part by record foreign investment as companies search for oil, coal and gold in areas that were once overrun by guerrillas and considered too dangerous to explore.

Direct investment from abroad jumped 58 percent in 2011 to a record $15 billion, with 81 percent going into oil and mining, according to trade balance data from the central bank. Foreign investment into stocks and bonds leaped almost five-fold to $1.23 billion in the last three months of 2011 from $263 million in the third quarter, the central bank data shows.

Job Loss

In a bid to ease gains in the currency, the central bank said Oct. 28 it will sell $200 million in dollar options to control the peso’s volatility. The sale will be triggered when the peso’s 20-day moving average changes by more than 4 percent. No options have been auctioned since the announcement.

Agriculture Minister Juan Camilo Restrepo yesterday asked the central bank not to “add fuel to the fire” by raising interest rates further as the peso’s rally has “strongly” hurt coffee, flower and banana exporters.

The currency’s jump this year has sparked outcries from companies dependent on sales abroad who say jobs are at risk as they get fewer pesos for their sales in dollars.

“Its very worrying,” Augusto Solano, president of the Association of Colombian Flower Exporters, said in a Jan. 24 interview on RCN Radio. “The pressure is so big some just can’t take it anymore.”

New Measures

Solano, who said 20,000 jobs in the flower industry have been lost in the past few years because of the peso’s rally, asked the government and central bank to adopt further measures to stem gains.

Those measures may come as soon as the Jan. 30 meeting, said Andres Pardo, the head analyst at financial services holding company Corp. Financiera Colombiana, known as Corficolombiana. He predicts the central bank will start buying dollars in the market again.

In September, Banco de la Republica ended a one-year program of purchasing a minimum of $20 million daily in the currency market to stem gains in the peso.

“The trend for a stronger peso will continue,” Pardo said. “There’s so much investor interest to explore Colombia, it’s now on everyone’s radar screen.”

To contact the reporters on this story: Andrea Jaramillo in Bogota at ajaramillo1@bloomberg.net.

To contact the editor responsible for this story: David Papadopoulos at papadopoulos@bloomberg.net.

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