Wall Street Looks to Latin America for 2018's Best Carry Trades

  • Argentina, Brazil seen delivering high carry trade returns
  • Interest rates to be more important than currency returns

Investors are targeting Latin America for the most profitable carry trades in 2018, betting a region that lagged behind peers last year is poised for a comeback.

Wall Street firms including Banco Bilbao Vizcaya Argentaria SA, Wells Fargo & Co. and Credit Agricole SA cite the region’s high interest rates and forecasts for faster economic growth. In Argentina, for example, a monetary policy rate of 28.75 percent is the highest in the world.

The banks are expecting a reversal from last year, when currency appreciation was the primary driver for the most profitable currency trades -- long positions in the Polish zloty and the Czech koruna funded by dollars. This time around, they’re anticipating that Latin American interest rates will provide the biggest returns even as forecasts call for most of the region’s currencies to slip.

“Latin America stands out,” said Eric Viloria, a strategist at Wells Fargo in New York. “Even after rate cuts in Brazil, the interest rates are still relatively high.”

Brazil’s real offered the top carry return in 2016, when interest rates were above 14 percent most of the year, handing investors gains of 37 percent. Last year, the central bank slashed borrowing costs to a record 7 percent, resulting in a carry return of just 5.5 percent. Still, the benchmark rate is higher than in peers like South Africa, India or Indonesia.

Viloria also highlights Mexico, where interest rates were lifted to 7.25 percent in December to fight surging inflation and surpassed Brazil’s rate for the first time ever. Traders are wagering Mexico’s rate will climb to 8.5 percent by the end of 2018.

Alejandro Cuadrado, the global head of foreign exchange at BBVA in New York, has the Argentine peso as his top carry pick for 2018, even as he forecasts a small depreciation. The country offered the best carry trade return in 2011, 2013, 2014 and 2015, but last year fell to 31rd place in the ranking as the peso’s 15 percent slide trimmed carry gains to 3.4 percent.

“This is backed by the persistent hawkish bias of the central bank,” he said.

Credit Agricole SA strategists led by Sebastien Barbe wrote in a Dec. 22 report that emerging-market currencies are likely to appreciate slightly versus the dollar this year. As interest rates remain relatively high, they see capital flows continuing to head toward developing nations.

“This is not the end of the EM carry trade yet,” the strategists wrote.

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