Brazilian and worldwide interest rates – 07/06/2023 – Rodrigo Zeidan

We are seeing the return of the “carry trade”, a global phenomenon in which investors borrow money in countries with low interest rates and buy government bonds where interest rates are high.

The result, in part, is currency devaluation in countries with low interest rates and appreciation in countries that pay high returns, at first. As an example, the yen is at its lowest level against the dollar since the 1980s. Not even at the height of the Japanese financial crisis of the 1990s was the yen so undervalued. The reason? The interest rate in Japan is at 0.1%, while in the US it is over 5% and, in Brazil, 13%.

In other words, many investors, betting on world stability, including the exchange rate, borrow money in Japan to invest in US Treasury bonds or Latin American countries, such as Brazil.

For much of the 2000s, this bet generated mountains of money. While interest rates in Brazil were around 20% and, in the rest of the world, around 4 to 5%, investors made money in the interest rate differential and in the appreciation of the Brazilian exchange rate; “carry trade” investors gained the most in the process of appreciation of the real from R$3.99 in 2001 to less than R$1.60 in 2008.

The spree ended in the financial crisis of 2008 and many funds lost a large part of their gains: “gains go up the stairs, while losses can go down the elevator” is one of the maxims of financial markets. Even so, there are potential gains with this type of strategy, which explains the recent appreciation of the real, which is systematically below R$ 5 per dollar. It’s not just in Brazil.

In the first half of 2023, among the seven world currencies that appreciated the most were the Colombian peso, the Mexican peso and the Chilean peso and the Peruvian sol. In common? These Latin American countries started raising interest rates well before the rest of the world.

Economic theory says that differences in international interest rates and the future exchange market incorporate expectations of future currency devaluation where interest rates are higher. The bet of investors is that this devaluation will not happen. In other words, international investors are, in a certain way, hoping that the administration of Lula 3 will not be very different from the first PT administration, in which the supercycle of commodities and good internal policies led to a constant appreciation of the Brazilian currency.

And if these bets increase, the Brazilian exchange rate will continue to appreciate, even if interest rates start to fall. Furthermore, if US interest rates start to rise, as it looks like the Fed will continue to do, the stakes will change: why buy Latin American bonds if Americans start paying absurd rates?

At the moment, the exchange rate appreciation brought by foreign investors (and by the trade balance) helps Bacen in the fight against inflation. In a short time, the time will come to let interest rates fall in Brazil. Those who make money with “carry trade” will not like it. But Brazilian inflation is close to being quelled. And even with the impact on the exchange rate, the best policy will be to lower interest rates. Meanwhile, gringos (and Brazilians) take advantage of the 13.75% of the Selic. Will it be that, when it drops from 10%, we will never see double-digit interest rates again? We can dream.

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