Brazil Real Notes Show Optimism Smart Money Rejects: CurrenciesKevin Dugan, Ye Xie and Blake Schmidt
Individual investors are buying record amounts of notes betting that Brazil’s real will continue its world-beating advance amid speculation the Federal Reserve will keep pumping money into the global economy into 2014.
The demand runs counter to the outlook from professional strategists, who predict a 5 percent drop in the real by the end of March. Goldman Sachs Group Inc. and HSBC Holdings Plc led $73.5 million of real-linked U.S. structured-note sales this year, surpassing the $66.5 million issued in 2011 when the real strengthened to a 12-year high, data compiled by Bloomberg show.
While Brazilian officials have sent mixed messages about continuing the market intervention that triggered the real’s 11 percent rally over the past two months, the currency is being spurred by the $85 billion that the Fed is pumping into the economy every month, some of which is flowing out of the U.S.
“It won’t be long before we start to hear speculation about the Fed’s tapering, and Brazil’s central bank will have to support the real again,” Hideaki Iha, a currency trader at Sao Paulo-based brokerage Fair Corretora de Cambio e Valores, said Oct. 21 in a phone interview. Still, “the central bank can’t let the real gain too much,” he said.
The real has rebounded from a 4 1/2-year low on Aug. 21, making it the best-performer among 31 major peers tracked by Bloomberg in the period. Until that date, it was the year’s worst after the South African rand, tumbling 16 percent. Brazil’s currency climbed to a four-month high of 2.1472 per dollar on Oct. 18 and was at 2.1883 at 11:46 a.m. in New York.
The rally started when Brazil announced its $60 billion intervention program on Aug. 22, and accelerated with Fed Chairman Ben S. Bernanke’s surprise Sept. 18 decision that U.S. policy makers would maintain stimulus until they saw evidence of a more sustained recovery.
The Fed will delay reducing its bond purchases until March after a 16-day federal government shutdown hurt growth, according to the median estimate of 40 economists surveyed Oct. 17-18, after a fiscal agreement broke the political deadlock. In a Sept. 18-19 poll, economists said the central bank would reduce the purchases from December.
Structured notes are debt securities packaged with derivatives, and allow investors to customize wagers on assets. They’re a way for individual investors, who tend to be excluded from the mainstream $5.3 trillion-a-day foreign-exchange market, to bet on currencies.
The 22 real-linked structured notes sold this year pay coupons that tend to be higher than equivalent-maturity U.S. Treasuries, provided the South American currency remains above a pre-set level for the lifetime of the security.
New York-based Goldman Sachs led the market this year, selling $34.3 million of the securities, up from $14.8 million in 2012, according to data compiled by Bloomberg.
London-based HSBC sold the second-highest amount as well as the largest offering, an $11.5 million deal April 5.
The one-year note yields 28.5 percent should the real gain 3 percent from the issue date, according to a prospectus filed with the U.S. Securities and Exchange Commission. U.S. Treasuries due in 12 months yield 0.096 percent, and the rate reached a high for this year of 0.168 percent in June, data compiled by Bloomberg show.
Before rebounding this year, yearly real-linked notes sales fell 24 percent in 2012, with investors instead preferring securities that gain when the Chinese yuan and the Mexican peso rise against the dollar, Bloomberg data since 2010 show.
While the market remains small, the sales signal optimism in the real that’s rare among banks and institutional investors. Brazil’s currency will weaken to 2.32 per dollar by March, according to the median estimate of more than 30 analysts surveyed by Bloomberg. On June 6, they were predicting a level of 2 per dollar.
Brazil’s central bank has been auctioning $1 billion of dollar loans every Friday since Aug. 23 and offering the equivalent of $500 million worth of foreign-exchange swaps each day, Monday through Thursday, to bolster the currency and control the price of imports.
“The notion that it’s offering some sort of guarantee is important for sentiment,” Sebastian Brown, a currency strategist at Barclays Plc in New York, said in an Oct. 21 phone interview.
While the Fed’s bond purchases “dwarf” local intervention, Brazil’s program has more influence on the real, Brown said. The U.K. bank predicts a decline to 2.4 reais per dollar by the end of the first quarter.
Finance Minister Guido Mantega said in September that Brazil may reduce its participation in currency markets. Central bank President Alexandre Tombini followed by saying this month that the program may continue after the scheduled Dec. 31 end date. Policy makers also failed initially to confirm whether they’d roll over all contracts maturing Nov. 1, though in a statement late yesterday said they’d hold auctions to extend the maturities of the contracts.
Brazil’s central bank “is a bit more hawkish than markets have given them credit for,” Win Thin, the global head of emerging-markets strategy at Brown Brothers Harriman & Co. in New York, said in an Oct. 21 phone interview. If policy makers don’t roll over swaps and credit programs, they’re “in a sense taking back their intervention to support the real,” he said.
Brazil’s central bank has raised its benchmark interest rate five times since April, to 9.5 percent from 7.25 percent, in order to damp inflation that has exceed the government’s 4.5 percent target for three years. That’s increasing the appeal of the real after policy makers around the world cut borrowing costs to records to stoke growth.
Deutsche Bank AG, the world’s largest currency trader, recommended in September that investors sell the real because it’s one of the “bad apples” of emerging-market currencies. The Frankfurt-based lender issued a $5.5 million, one-year note March 1, though it hasn’t sold such securities since making its bearish call last month, data compiled by Bloomberg show.
Amanda Williams, a spokeswoman for Deutsche Bank in New York, declined to comment on her bank’s sales of real-linked structured notes, as did Tiffany Galvin of Goldman Sachs and HSBC’s Juanita Gutierrez.
Deutsche Bank cited a possible credit-rating downgrade and the biggest current-account deficit in 11 years for its pessimistic view on Brazil, which, for a decade through 2010, benefited from the growing power of developing nations, forming with Russia, India and China a group known by the BRIC acronym.
The deficit in Brazil’s current account, the broadest measure of trade, jumped to 3.6 percent of gross domestic product in August, the most since 2002, Bloomberg data show.
Gross domestic product will expand 2.4 percent this year and 2.5 percent in 2014, compared with 5.2 percent in 2008, before the worst of the global financial crisis, according to economists surveyed by Bloomberg.
Moody’s Investors Service cut the nation’s Baa2 sovereign rating -- two levels above junk status -- to “stable” from “positive” on Oct. 2, citing deteriorating debt and investment ratios and slow growth.
“The central bank may continue hiking rates into next year,” Claire Dissaux, the managing director of global economics and strategy at Millennium Global Investments in London, said in a phone interview yesterday. “But long-term, Brazil still faces structural issues” which “does not bode well for medium-term real prospects.”