Japan investors target Brazil for yen carry-trade bets

Wed May 14, 2014 1:53am EDT

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By Lisa Twaronite

TOKYO, May 14 (Reuters) - The wide gap between Japan's interest rates and those of Brazil's has attracted investors to the yen carry-trade for Brazilian assets in spite of emerging market risks.

Borrowing cheap yen to fund purchases of Brazilian stocks and bonds has proven a winning strategy so far this year. Some analysts, however, think investor sentiment could cool with Brazil's interest rates not expected to rise further and on potential political risks.

The Bank of Japan's massive monetary stimulus unfurled 13 months ago has kept Japanese rates at rock-bottom levels, in sharp contrast with Brazil's 11 percent benchmark.

With most other major currencies such as the dollar and the euro offering yields only slightly better than the yen, retail and institutional investors are looking to higher-yielding emerging markets. The feel-good factor of the forthcoming World Cup is also giving sentiment towards Brazil a boost.

"With all the hype of the World Cup, the overall sentiment is one of buoyancy," said Bart Wakabayashi, head of forex at State Street Global Markets in Tokyo. "There's still reason to like the long-Brazil trade."

Although a slowing Brazilian economy dented Japanese appetite for the real in 2012-13, the real became popular again after the Brazilian central bank raised its benchmark Selic by a total of 3.75 percentage points in nine straight increases since April 2013. But with the country's inflation rate rising less than expected in April, expectations are growing the central bank will pause its monetary tightening cycle.

SEEKING YIELD ABROAD

BRL-denominated uridashi -- bonds targeted at Japanese retail investors -- rose sharply this year as a percentage of emerging market issuance, even as total uridashi issuance has shrunk, Brown Brothers Harriman data show.

As of last month, BRL-denominated uridashi issuance has comprised more than half of total emerging market uridashi issuance, up from an average share of 29 percent in 2007-2013.

The potential for hefty returns has not escaped the notice of even some traditionally conservative Japanese investors, and market sources with access to institutional flow data cite increased carry-trade activity in recent months.

A senior official at Japan's second-largest private life insurer Dai-ichi Life Insurance Co told a news conference last month the insurer would not buy Japanese government bonds at current low yields and that it added Brazil to its stock and bond portfolios last financial year.

According to Thomson Reuters Eikon's carry trade model, a yen investment in the Brazilian real would have earned more than 7 percent so far this year, with Sharpe ratio of 1.93, a level that suggests a good return in comparison to risk.

In comparison, the Australian dollar returned about 3.6 percent with Sharpe ratio of 1.57.

The real has gained about 5 percent against the U.S. dollar but it has stabilised since mid-April as the market expects Brazilian rates to stop rising soon, leading some market players to question how long investors will keep buying.

"Our clients who have already invested in Brazil ask about the risks," said Masashi Murata, senior currency strategist at Brown Brothers Harriman in Tokyo. "Most say they want to wait until the next central bank meeting, because they want to check the stance on hiking rates," he said.

A shift in Brazil's monetary policy could come even before the World Cup's June 12 kick-off. The Banco Central do Brasil will conclude a two-day meeting on May 28, which could herald the end of the widening of the interest rate differentials that have made the trade so attractive.

Brazil's October presidential election also clouds the outlook. President Dilma Rousseff was once considered the favorite to win a second term, but has slipped in recent polls, and an upset could lead to market volatility.

"The recent situation is good for Brazil, but some professional investors think U.S. Treasury yields will rise more, so they don't have to invest in riskier assets, like Brazil's, for higher yields," Murata said. (Additional reporting by Hideyuki Sano; Editing by Jacqueline Wong)

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