Brazil Carry Trade Beckons Investors Ignoring Political Risk

Updated on
  • Volatility declines as traders cut real depreciation bets
  • Real offers Latin America’s second-best carry-trade potential

Investors scared off by Brazil’s political turmoil are returning to its currency, lured by the potential for Latin America’s second-highest carry return.

The selloff in the real immediately after fresh corruption allegations were leveled at President Michel Temer last month has now subsided, with one-month price swings falling below expected volatility levels based on options prices. Traders of forward contracts have cut their bets for depreciation to a 14-month low, according to data compiled by Bloomberg.

The optimism suggests investors largely expect Temer to survive accusations he endorsed hush-money payments to a disgraced congressman as part of a broader corruption scheme. Confident that he’ll make progress with the economic-policy changes he has championed, they are flocking to carry trades in the real amid wagers the slowest annual inflation in a decade will allow the central bank to keep cutting interest rates aggressively.

"The Brazilian real is one of the most attractive currencies in terms of carry to volatility," said Gabriel Gersztein, BNP Paribas’s head of foreign exchange and rates for Latin America, who sees the currency appreciating to 3 per dollar by year-end.

The real is projected to yield the second-highest carry return among Latin American currencies, based on implied yields adjusted for implied volatility.

Brazil’s chief prosecutor, Rodrigo Janot, may present charges against Temer in the coming days, according to local media reports. The president, who already survived a trial on illegal campaign financing in Brazil’s electoral court this month, has defied calls to resign, saying he did nothing wrong and the probe will prove it. The scandal led to a 7 percent slump in the real May 18, though the currency has recovered some losses since then.

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The cloudy political outlook initially prompted the central bank to signal it may reduce the pace of monetary easing, after shaving 4 percentage points off the benchmark Selic rate since October. However, consumer inflation for May came in below analysts’ forecasts, prompting investors to speculate that policy makers will go back to their aggressive cutting mode.

The implied yield on the real for the one-month tenor, based on prices of non-deliverable forwards, fell to 8.86 percent on Tuesday, heading for the lowest since November 2013. The real fell 0.7 percent to 3.3062 per dollar as of 10:47 a.m. in New York on Tuesday.

Concerns over Temer’s potential impeachment or resignation were overdone and didn’t reflect structural or fundamental issues, according to Shamaila Khan, the director of emerging markets at AllianceBernstein, which holds Brazilian bonds.

"There is a high probability that the progress on reform continues despite the political volatility," she said.

— With assistance by Julia Leite

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