We believe both the local bond markets and the foreign exchange rate have recently come under pressure as investors re-evaluate Brazil’s prospects over the short term. The combination of inflation remaining above the central bank’s comfort zone and economic growth projections that were recently revised down has seen dark clouds creeping over Brazilian markets. Over the past several weeks, the market has moved lower as the real weakened to levels not seen since the global financial crisis.4 However, we do not believe Brazil is facing the same types of headwinds that it was facing in 2009. Through the combination of some of the highest interest rates in Latin America and a currency that has come under pressure, we believe that Brazilian debt could provide an attractive risk/reward for medium- or long-term investors.
As shown in the table above, Brazil currently offers some of the highest yields in all of Latin America. While the potential for near-term volatility is still present in many of these markets, Brazil offers a potential “cushion” against further currency weakness due to its higher rates. Should some of the negative clouds regarding economic growth lift, we believe the real could trade higher than its current depressed levels.
Recently, the ratings agency Standard & Poor’s revised its ratings outlook for Brazil from stable to negative. The agency noted the potential for a continued deterioration in the growth outlook combined with Brazil’s current fiscal and external vulnerabilities as the reason for the announcement. In our view, we believe this could serve as a shot across the bow for Brazil and other EM countries to continue their efforts to further reduce external vulnerability. After a series of upgrades in credit ratings for many EM countries by the ratings agencies in the past few months S&P’s announcement has caused an already fragile market to weaken further. Even though the near-term headwinds appear to continue, we believe that Brazil may still present an attractive risk/reward near current levels.
While the impact of the announcement of the removal of the Financial Transaction Tax was muted by other market forces, we view this development as a longer-term positive for investment in the Brazilian bond market. For some investors, high levels of carry and a currency trading near multi-year highs may provide an attractive option for diversifying away from U.S. dollar-based investments.
Rick Harper is head of fixed income and currency for WisdomTree Asset Management. This post was republished with permission from the WisdomTree blog.
1IOF: Imposto sobre Operações Financeiras (Portugese)
2Standard & Poor’s, June 7, 2013.
3Source: Standard Chartered Bank, June 6, 2013.
4Source: Bloomberg, June 11, 2013.