Yen-Funded Carry Trade Holds in Latin America Despite Real Slump After Brazil Vote

Financial-market volatility has increased since Brazil’s presidential election, but demand for Latin American carry trades funded with the Japanese yen appears to be holding up.

Bloomberg reported on October 26 that the Brazilian real has plunged against the yen since the re-election of Brazilian President Luiz Inacio Lula da Silva, while other major Latin American currencies including the Chilean peso, Colombian peso and Mexican peso have gained.

The moves suggest investors are still actively borrowing yen at Japan’s low interest rates and investing in relatively higher-yielding Latin American assets. The strategy profits from interest-rate differentials between countries, but investors can suffer foreign-exchange losses if the target currency falls sharply.

“The basic structure supporting the carry trade remains intact,” Fukuhiro Ezawa, head of financial markets at Standard Chartered in Japan, said. Trading in the Brazilian real is limited during Asian hours, and Japanese investors’ related positions are not large, he added, suggesting any spillover into Japan’s financial markets would be limited.

Brazilian financial markets have come under selling pressure since Lula’s re-election as concerns about fiscal soundness have come to the fore. Investors are wary that Brazil’s fiscal position is deteriorating quickly and that the new government may fail to come up with an adequate response.

Still, the relative resilience of major Latin American currencies outside Brazil has kept the broader carry-trade picture from weakening. A wide interest-rate gap between Latin American countries and Japan is continuing to support investor demand.

Market participants view the yen as likely to remain a funding currency for carry trades unless risks in emerging-market financial markets increase sharply. That could keep selling pressure on the Japanese currency in place for the time being.