Investors' ravenous appetite for higher yield assets in a world of low interest rates are driving Latin American currencies to multi-year highs. Investors are rushing to buy up assets in emerging economies such as Brazil and Mexico which have much higher interest rates than the United States, and where current account balances are positive, analysts said.
Brazil has one of the world's highest overnight interest rates at 19.75 percent, helping push its currency, the real, to a 3-year closing high of 2.385 per dollar last Friday. In intraday trading this Friday, the real flirted with that peak.
"Countries with currencies, where there are very large trade surpluses and have high yield, remain attractive, and Brazil is the mother of all those currencies," said Clyde Wardle, emerging markets forex strategist at HSBC Securities.
With US Treasury yields falling below 4.0 percent on the benchmark 10-year note, investors are moving capital out of the United States, the eurozone and Japan to emerging markets with higher-risk but also higher yields.
Capital inflows to Brazil were heavy through April and early May after investors realised the country's central bank had finished selling rais to buy dollars to build foreign reserves by March.
"That was the greenlight (to investors) to see how far the currency could go," Wardle said.
With suggestions from US Federal Reserve officials that US interest rates may be close to a peak, investors are increasingly prepared to borrow in US dollars to fund investments producing higher yields in other countries.
"The perception is that the US interest rate environment will remain benign and therefore risk appetite will remain high, so investors are still chasing high yield," said Suhas Ketkar, senior economist at Royal Bank of Scotland.
Thus the so-called "carry trade", borrowing short-term money at low interest rates and investing it in higher-yielding long-dated securities, such as emerging market debt, to profit from the difference in rates, is becoming popular again.
"Brazil stand out in that respect, unless you are extremely worried about local conditions in Brazil, the carry is enough to trump other global market moves," said Michael Hood, Latin America economist at Barclay's Capital.
Brazil's economy slowed more than expected in the first quarter after a series of interest rate increases stifled domestic consumption and capital investments by companies.
Growing corruption allegations also worried markets adding risk, but not enough to affect investors searching for yield.
"You will have a hard time finding anything anywhere in the world that pays you more than being long in Brazil," Hood said.
The Mexican peso meanwhile, has also shown high returns due to high interest rates, workers remittances, and high oil prices.
The peso closed at a 16-month high against the US dollar of 10.8080 per dollar on Thursday, as investors bought into relatively attractive local debt. In Friday morning intraday trade it strengthened to 10.8000 per dollar.
Analysts said Mexico's central bank monetary policy is likely to diverge from the US Fed's by July once Mexico's tightening cycle ends its course. The overnight lending rate in Mexico is around 9.6 percent.
"Once (the Mexican) bank signals that tightening is gone far enough, 10 percent would be the peak for Mexican interest rates, you will see rates held steady and possibly even cut as inflation falls in the second half of the year," Wardle said.
Investors want to lock in higher yields before the central bank acts. That may be bringing some foreign money into the country and persuading some local investors to buy bonds with longer maturities, Ketkar said.
"It's a two step process. In the first step the currencies tend to appreciate. Once rates come down and rate differential against majors narrows then the currencies will begin to weaken out a little bit, but that is the second step," Ketkar added.
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