Investors who bet on Brazil’s local bonds this year were saddled with the biggest losses among major economies. The outlook for 2016 isn’t much better.
Borrowing dollars at the end of 2014 and buying reais, a practice known as the carry trade, left investors with losses of 22 percent as Brazil’s currency posted the second-biggest slump in emerging markets amid political turmoil, the country’s worst recession in 25 years and two credit-rating cuts to junk. The loss was almost twice that for traders who bought Mexico’s peso and four times that of the Korean won.
Investors got burned after being lured to Brazil by interest rates near 15 percent, the highest among major economies, which offered an alternative to benchmarks of less than 1 percent from the U.S. to Europe and Japan. While borrowing costs in Brazil are forecast to climb even higher in 2016, analysts predict the real will post the biggest losses among major currencies as the economy contracts for a second straight year. The currency is already the world’s most volatile amid turmoil created by a corruption scandal tied to the state oil company and a push to impeach President Dilma Rousseff.
“Uncertainty is huge in Brazil today, and carry-trade strategies become extremely difficult to be effective when you have such high volatility,” said Paulo Nepomuceno, a fixed-income strategist at Coinvalores CCVM in Sao Paulo, who has covered fixed-income, foreign exchange and derivatives for 30 years. “Gains are not guaranteed despite the high interest rate locally. I don’t see an improvement happening in the short-term.”
Real-denominated sovereign notes posted an average loss of 29 percent this year, more than twice the drop for emerging markets and close to 10 percentage points worse than the average slump in Latin American countries, according to indexes from JPMorgan Chase & Co. One-month implied volatility on options for the real, reflecting projected shifts in the exchange rate, was the highest among 16 major currencies tracked by Bloomberg, at 22.6 percent as of 7:40 a.m. in New York on Wednesday. It increased 7.74 percentage points this year.
Policy makers will increase borrowing costs to 15.25 percent next year from the current 14.25 percent, according to a central bank survey of about 100 economists released this week. Analysts expect inflation to slow to 6.86 percent at the end of 2016, above the 6.5 percent upper limit of the central bank’s target range. Business and consumer confidence are near record lows.
“I’ve seen many crises before, but can’t remember such low confidence levels,” Nepomuceno said. “People don’t have an idea of what is to come, so there is no way you can stick to your bets in the currency or domestic market. It will be a tough year.”
This article is for general information purposes only. It is not investment advice or a solution to buy or sell securities. Opinions are the authors; not necessarily that of OANDA Corporation or any of its affiliates, subsidiaries, officers or directors. Leveraged trading is high risk and not suitable for all. You could lose all of your deposited funds.