Brazil Currency Hedges Lose Luster With CFOs as Volatility Easesby
Most common hedging instrument fell to $112 billion as of Dec.
Real's implied volatility declines most among peers in 2016
The worst-performing major currency of 2015 is sidestepping the worst of the market turmoil this year, and companies are set to reap the benefits.
Brazil’s real has seen the biggest drop in anticipated price swings among the 16 most-traded currencies since Dec. 31, after posting the sharpest increase last year. The outstanding amount of contracts in Brazil designed to protect against currency volatility, most of which are bought by companies looking to hedge risk, fell by 18 percent in the final quarter of 2015 from a record high in September.
While the real is less than 5 percent from its all-time low amid a widening budget deficit, the worst recession in more than a century and political turmoil, swings are abating as traders turn their attention to bigger global challenges. A slowdown in China’s economy, tumbling oil prices and bear markets in stocks mean the relative calm in Brazil marks a contrast with the rest of the world as 2016 gets underway.
“In September, there were many concerns about how things would evolve domestically -- nobody knew exactly what was coming, and many companies were willing to pay whatever price was needed to hedge," said Fabio Zenaro, who oversees trading products including currency forwards at Cetip SA, Brazil’s biggest clearing house in Sao Paulo. Now “it is less volatile, so it makes it easier for companies to make forecasts and implement different hedging strategies.”
While no one would say the real is doing well -- it’s down 37 percent in the past 12 months and reached a record 4.2478 per dollar in September -- it’s starting to stabilize.
Implied three-month volatility fell to 19 percent on Tuesday, down from a four-year high of 25.6 percent in late September. That’s the biggest drop, both this year and from its peak, among 16 major currencies tracked by Bloomberg.
The median estimate of more than 30 strategists surveyed by Bloomberg has the real weakening 3.5 percent from Tuesday’s close of 4.0514 per dollar to 4.2 by year-end. That puts it in the middle among forecasts for the world’s top currencies. The real declined 0.9 percent to 4.0882 per dollar as of 4:50 p.m. in Sao Paulo.
The total notional value for long and short positions of over-the-counter non-deliverable forward contracts, the most common hedging instrument used by companies in Brazil excluding banks, totaled $112 billion at the end of December, according to Cetip, which registers the transactions. That’s down from a record-high of $134.5 billion on Sept. 1.
“September was a month of high volatility, and we saw a rush for protection at that time -- people were afraid the real could breach the 4.25-per-dollar level,” said Cleber Alessie, a currency trader at H.Commcor in Sao Paulo, who counts commodity producers among his clients. “Things settled down after that,” giving “more clarity to companies."
Companies rushed to hedge currency exposure last year as political turmoil in Congress and efforts to impeach President Dilma Rousseff threatened the nation’s finances. Standard & Poor’s and Fitch Ratings lowered the sovereign’s rating to junk, upending an economy that had enjoyed investment-grade status since 2008, when it was in the midst of a commodities-led boom.
The real fell so fast last year that meat producer JBS SA made more money betting against it in the nine months through September than it did from selling beef, chicken and pork, the company’s financial documents show. JBS’s press office declined to comment on its hedging strategy.
At the same time, the company is spending more than 4 billion reais ($978 million) -- twice what it earned in 2014 -- in interest a year to carry a derivatives position totaling $10.4 billion, the largest for any non-financial company in Brazil. Derivatives are contracts, such as forwards, based on another financial instrument.
Ambev SA, the Brazilian unit of brewer Anheuser-Busch InBev NV, spent so much hedging against losses that it offset some of the savings it would have gotten from falling commodity prices, Chief Financial Officer Nelson Jamel said in a conference call with analysts Oct 30. Ambev’s press office declined to comment.
Currency hedges are particularly expensive in Brazil because of the huge difference between local interest rates and those in developed nations, a cost that companies betting against the real have to cover. The Latin American nation’s benchmark interest rate is 14.25 percent, the highest among major economies tracked by Bloomberg and compared with no more than 0.5 percent in the U.S.
Because the contracts are so expensive, many Brazilian companies buy short-term hedges that last just three months or less, and many of those contracts expire without being renewed, according to Cetip’s Zenaro. The average maturity for non-deliverable forward contracts last year was between 30 and 90 days, Cetip data show.
“It becomes very expensive for companies to hedge for a long period,” Zenaro said. “Very few players are able to do it.”