Brazil Yields to Traders Pouncing on Gains: CurrenciesJoseph Ciolli and Ye Xie
Efforts by Brazil to tame inflation are providing foreign-exchange traders with the biggest returns in the world by purchasing reais with funds borrowed in dollars.
Investing in real forward contracts funded by the greenback has gained 5.3 percent this year, the most of any of the 44 other currencies tracked by Bloomberg. Wagers that Brazil’s currency will rise outpaced those expecting a decline by an average of $5.6 billion this year, data from the Sao Paulo-based BM&F exchange and compiled by Bloomberg show. As recently as September there were net bets against the real.
Finance Minister Guido Mantega, who popularized the term “currency war” in 2010, told Bloomberg News last month he’s abandoning the strategy that drove the real down 19 percent in two years as the government shifts its focus to containing inflation. The central bank signaled on March 6 that it’s ready to raise interest rates from a record low 7.25 percent after dropping a pledge to hold borrowing costs steady for what it had called “a prolonged period of time.”
“This year we’ve seen a shift from the policy makers’ standpoint from a clear depreciation bias throughout the majority of 2012 to a more appreciation bias,” said Michael Moran, a senior currency strategist at Standard Chartered Plc in New York. “It’s an interim approach to head off some of the inflation pressures which have started to pick up.”
The real has gained 4.3 percent this year to 1.9675 per dollar at 10:07 a.m. New York time, the biggest gain among 32 major currencies tracked by Bloomberg. The Mexican peso is the second-best performer, advancing 3.5 percent.
Standard Chartered sees the real gaining to 1.92 per dollar by year-end, putting it among the most bullish forecasts of 31 compiled by Bloomberg. UBS AG and Landesbank Baden-Wuerttemberg call for the largest rise, expecting 1.85 per dollar. The median estimate is for the real to end the year at 1.99 per dollar.
In the so-called carry trade, investors buy high-yielding currencies with money borrowed in countries with low interest rates. The risk is that adverse currency moves or heightened volatility wipe out profits generated by the difference in interest rates.
Pacific Investment Management Co., the world’s biggest manager of bond funds, is positioned to benefit from gains in the real versus the New Zealand and Australian dollars as China’s economy slows.
“New Zealand and Australia will be similarly impacted as China begins to slow down over the balance of 2013,” said Robert Mead, Sydney-based head of portfolio management at Pimco, in an interview today. “When we run a short Aussie position we’ve compensated by doing things like being long Brazilian real so you turn a negative 3 percent carry position into a positive 4 percent position.”
A short position is a bet a currency will decline in value.
The Aussie has declined 4.3 percent against the real this year, while the kiwi dollar is down 5.1 percent.
Interest-rate swaps show traders anticipate Brazil’s central bank will boost the benchmark Selic rate to about 9 percent by year-end, the highest among the 14 biggest emerging markets, according to data compiled by HSBC Plc. Key rates in the U.S., Japan and the euro zone are no more than 0.75 percent.
Brazil pushed the real down 22 percent from as high as
1.5290 per dollar in July 2011 through December by raising taxes on currency trading and buying dollars as Mantega said developed economies were debasing their currencies, driving up those of emerging nations.
The central bank let the real appreciate in January through 2 per dollar for the first time in six months, prompting traders at banks, including Standard Chartered, to call for a policy shift that favors a stronger currency. A higher exchange rate helps lower consumer prices by making imports cheaper.
The policy reversal came as inflation accelerated to 6.31 percent in February, the fastest pace since December 2011. The central bank aims to keep consumer-price increases at 4.5 percent, plus or minus two percentage points.
Mantega said in his interview with Bloomberg that last year’s policies, which included the biggest interest-rate cuts among Group of 20 nations, capital controls and tax cuts, laid the path for faster growth in 2013. Brazil’s gross domestic product expanded 0.9 percent in 2012, the second slowest pace since 1999. It will grow 3.5 percent this year, according to the median forecast of 30 economists in a Bloomberg survey.
“We haven’t resolved it, but we neutralized, softened the currency-war issue that other countries are facing,” Mantega said in the Feb. 27 interview at Bloomberg’s headquarters in New York. “We are in Brazil in a transition to a more solid, competitive and efficient economy.”
Having a more stable currency in 2013 will help curb inflation and aid growth, central-bank President Alexandre Tombini said at a conference in New York on Feb. 25. Inflation will slow in the second half as the country produces a bumper crop of grains that will help contain food-price increases, he said.
The central bank kept interest rates steady on March 6 and said in a statement it would assess “the macroeconomic scenario” at its next meeting starting April 16. Policy makers last raised rates in July 2011.
Before increasing borrowing costs, Brazil’s policy makers will allow the currency to rise to buy them time in controlling inflation, according to Sireen Harajli of Credit Agricole SA.
“Brazil will want to wait a little bit until the growth recovery is a little more solid before they feel comfortable raising interest rates,” Harajli, a foreign-exchange strategist in New York, said in a March 5 telephone interview. “They might sound more hawkish just to prepare the markets for a rate hike, but for now they’ll just let the currency increase.”
Policy makers will walk a fine line between letting the exchange-rate rise to help contain inflation and avoid excessive currency appreciation to harm domestic industries when growth remains weak, said Gustavo Arteta, an emerging markets foreign-exchange strategist for Latin America at UBS AG.
“Even though it has regained some of what it lost, it still has a good road still ahead of it,” Arteta said in a Feb. 21 telephone interview. “The question is how fast and how far does the central bank want to allow it to go.”
The real’s appeal might be reduced if the Federal Reserve alters its current monetary stance, according to Peter Kinsella of Commerzbank AG. If the market starts expecting a withdrawal of the Fed’s “ultra-accommodative” policy and pricing in interest-rate increases, emerging-market currencies maybe be negatively affected, he said.
“You’re looking at a potentially large dollar move,” Peter Kinsella, a Latin America currency strategist in London, said in a March 5 interview. “In the second half of this year, you’ll probably see a shift from emerging-market fixed income back toward developed-market fixed income. We can certainly rule out aggressive strength for the real.”
Over the past two months, policy makers have been buying and selling currency swaps to keep the real in a range between
1.95 and 2 per dollar. The central bank sold $1 billion of reverse swaps on March 11 after the real strengthened through
1.95 per dollar for the first time since May. The swaps are equivalent to buying dollars in the futures market.
Such intervention has limited currency volatility, which encourages carry trades by making the return more predictable.
Implied volatility on one-month real options, which reflects investors’ expectations for future currency swings, hit a record low 5.3 percent on Nov. 7, down from 15 percent at the end of June, and was at 7.38 percent today, according to data compiled by Bloomberg.
In the options market, investors the least bearish on the real in more than 18 months.
Traders are paying a 3.75 percent premium for contracts granting them the right to sell the real, relative to options for buying the currency, one-year 25-delta option risk reversal rates show. The one-year average is 5.38 percent.
“Traditionally, too much intervention is not very positive and comes with many consequences,” Credit Agricole’s Harajli said. “This is one example where we’ve seen inflation get a little bit out of control because a currency was kept low for so long. Brazil is now likely to fight excessive inflation by letting their currency appreciate.”
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