Brazil’s decision to hike its key interest rate to 11%, its highest level in two years, has again started to attract investors since there are also strong hopes that Brazil’s next president to be elected in October will rein in spending and adjust macroeconomic policies.
However the big question is whether Brazil’s currency, the Real, will sink further and wipe out returns on real-denominated bonds. For some the danger is modest enough to handle, especially for the double digit yields.
Brazil’s Central Bank on Wednesday raised interest rates for the ninth straight time, extending one of the world’s longest rate tightening cycles after a surge in food prices added to the country’s already high inflation. Since April 2013, the Central Bank has increased its benchmark interest rate 3.75 percentage points.
That has prompted some investors, who had been rushing out of the country’s equity market over concerns about high inflation and tepid growth, to consider Brazilian bonds. Brazil’s 10-year bond yields 12.8% in local currency, compared with a yield of 2.79% for a 10-year note in the United States.
But investors who buy fixed income securities run the risk that inflation will continue to cut into real returns. On March 27, Brazil’s central bank increased its 2014 inflation forecast to 6.1% from its earlier estimate of 5.7%, and raised its 2015 inflation estimate to 5.5%.
Those moves have come amid wide swings in the value of Brazil’s currency. Since January 2013, the value of the Real against the dollar has fallen approximately 15%, from 1.96 per dollar to 2.26. Should the Real continue to fall, US-based investors who convert their earnings from Real to US dollars will see the value of their positions erode.
Foreign investors typically cannot buy Brazilian bonds directly unless they put in a large order through their broker. And, with no exchange-traded funds investing solely in Brazilian debt, analysts say the best alternative are emerging markets bond ETFs which count Brazil among their largest country allocations.