Hot money flows burn Brazil’s trade

WITH US interest rates being kept artificially low, hot money flows are hitting emerging market economies hard. With the US overnight rate currently being held around zero, the Bric countries in particular are being hit as investors try to get the highest short-term interest rates possible. But now Brazil is really starting to hurt, as high interest rates have made the Brazilian real a prime target for carry trades.

Chris Towner, director of FX advisory services at HiFX, points out that Brazil is stuck between a monetary rock and a hard place. “The Brazilians are facing a dilemma between a very attractive economy enticing foreign investment and a very strong currency hindering exports.”

Some investors are now shying away from investing in Latin America. Henry Lancaster, senior investment analyst at Coutts, says that they favour strong-growth economies in Asia where monetary policy has stayed ahead of inflation. Soaring inflation means that Sao Paulo has become a more expensive place to live than London.

Brazilian finance minister Guido Mantega has previously referred to the issue as a “currency war that is turning into a trade war” and at a press conference in London on Tuesday he announced that the government would step in to restrain the speculatory influences that have driven the real to its current highly overvalued levels. However Peter Kinsella , FX strategist for Commerzbank corporates and markets, downplays the minister’s words “The comments by the finance minister are quite moderate by his standards.” According to Kinsella: “If they are actually serious about this issue then they would have to implement further capital controls, which is the antithesis of most emerging market economic doctrines.”

According to Benoit Anne, head of emerging market strategy at Societe Generale, there is limited upside for further appreciation and the threat of intervention is imminent. As a result, he sees R$1.55 as an important level to watch for.

Though the policy makers of emerging markets are looking at ways to control appreciation, there is a limit to what they can achieve. “It is very hard to comment on what the government may do – clearly fundamentals more than anything else have driven the recent appreciation of the Brazilian real” says Will Landers, Fund Manager, BlackRock Latin American Investment Trust. “The central bank should raise rates twice more this year to 12.75 per cent to ensure that inflation expectations converge to the centre of the stated target at 4.50 per cent for year-end 2012.” And as Stephen Barber, adviser to Selftrade on markets and economics, points out, it is unlikely that we will see any US rate hikes this side of a presidential election. As such, Brazil, along with other emerging market economies, is going to have to deal with strong currencies for the foreseeable future.