The Real's in demand, and it's got nothing to do with the Olympics ....

Thursday 8th September 2016

The Real's in demand, and it's got nothing to do with the Olympics ....

ref:- "Brazil Real Climbs as ECB and Inflation Boost Carry Trade Appeal", Bloomberg Markets

If Brazil has been in the spotlight of late then for most people it would be its status as host of the Olympic and Paralympic games that been attracting attention. Some may have been keeping a closer eye on the basket-case that is Brazilian politics with the impeachment of former president Dilma Rousseff, or the very serious problems facing its previously booming economy after the about-turn made by commodity prices. But apart from those travelling from abroad to participate in the Olympic extravaganza, only a sad, market-based minority would have much interest in the fortunes of the Brazilian Real when there's so much else to occupy the mind. Sadly, we are forced to conclude that minority probably includes us .....

Still, it's interesting (in its way) because despite all Brazil's political and economic woes, its currency is performing strongly. That's because of interest rate differentials of course, and they have made the Real the beneficiary of the current Carry Trade of choice. Wouldn't that happen with any currency supported by high interest rates? Well, not if the market felt that there was any genuine chance of the currency imploding. But Brazil is a G20 country remember, and investors maintain enough faith to believe that a new government might get the economy back on track.

So what makes the Real so attractive for carry-traders? The Euro has a refinancing rate of zero and a deposit rate of -0.4%, and whilst the ECB didn't add even more stimulus today, the expectation is that they will. The effective benchmark rate in the States is 0.5%, and every time Fed officials start to talk about a hike some piece of data comes along to undermine them. Contrast that with Brazil, where the rate is 14.25% (the highest amongst major economies) and where stubbornly high inflation numbers discourage talk of cuts anytime soon. Not surprising therefore that borrowing Euros to buy the Real for example in order to take advantage of the interest rate differential has returned 30% this year, the most amongst 40 currencies tracked by Bloomberg for carry-trade returns.

Over the last year say, the man in the street is likely to only have read of Brazil's corrupt politics and chaotic economics. The fact is however that over that period the Real has strengthened from its weakest point against the US dollar of about 4.17 to its current 3.20, and from 4.67 against the Euro to about 3.61. Brazilian assets have led global gains this year, and on-the-spot analysts such as Italo Abucater of ICAP Brasil see USD / BRL down to 2.9 within a couple of months  --  not necessarily what one might have expected from a distance.

Make no mistake, the new government faces an almighty task in trying to reform the economy. But for now at least, the Real remains well bid.