Emerging-market currency volatility has dropped to its lowest point since the beginning of the year, re-energizing carry trades, particularly those in Latin America. The region offers higher interest rates compared to most developing-nation peers, allowing investors to profit from borrowing in low-rate currencies and investing in those with a premium. Latin American currencies also boast the most attractive carry-to-risk ratios in emerging markets.
A strategy involving borrowing in the dollar and buying the Colombian peso has yielded a 22% return, while a similar approach with the Brazilian real gained 12.9%, and the Argentine peso climbed 12.8%. In contrast, trades involving the Polish zloty, Indonesian rupiah, and Thai baht all recorded losses of at least 5%. The Brazilian real leads all emerging-market currencies in the carry-to-risk metric with a score of 1.33, with the Colombian peso at 1.31 and the Mexican peso at 0.91.
Lower volatility, described by ING Bank NV's Chris Turner as a key factor steering carry trade money towards Latin America, is crucial for preserving interest rate advantages from adverse currency fluctuations. Latin American central banks had previously tightened monetary policies, leading to high nominal rates, and with weakening inflation, high real yields further boost the attractiveness of these currencies. Furthermore, many countries in the region are oil exporters, providing insulation from the impact of higher oil prices, particularly as the Iran war escalates again. Wall Street banks, including Citigroup Inc. and JPMorgan Chase & Co., are favoring higher-yielding Latin American currencies, with Citigroup recommending a basket including the Brazilian real, Colombian peso, Mexican peso, and Turkish lira.
Local market catalysts are also influencing currency performance. Colombia's market-friendly election outcome and the central bank's stance on interest rate hikes are positive factors, while in Brazil, domestic politics may be trending towards less market-friendly outcomes, and the central bank might consider cutting rates as early as August. Despite the optimism, analysts like Edwin Gutierrez of Aberdeen caution that Latin America is not without risk, citing concerns about fiscal consolidation in Colombia and upcoming elections in Brazil.
