For months, the Brazilian real was one of the hottest bets in emerging-market currencies. Then June hit, and the currency got hammered.
The real's decline represents a sharp reversal from earlier in the year, when it was a top performer among emerging-market currencies. The carry trade had been highly profitable as Brazil's high interest rates attracted foreign capital, but the combination of a hawkish US Fed and a dovish Brazil central bank upended that strategy.
Kevin Warsh took over as chair of the US Federal Reserve in June. In his first month, he struck a hawkish tone - meaning he signaled that interest rates might stay higher for longer. That sent the Bloomberg Dollar Spot Index to 1,222.23, its highest level of the year.
Higher US rates reduce the appeal of carry trades. A carry trade is when investors borrow cheap dollars to buy higher-yielding currencies like the real. When the dollar looks set to stay strong, that trade becomes less profitable. So investors sold reals and bought dollars back.
The result: one US dollar now buys 5.16 Brazilian reals. The MSCI emerging-market currency index, which tracks a basket of developing-world currencies, fell 1% in June.
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"It was definitely a tough month for the real, which had remained one of the market's favorite emerging-market currencies," remarked RBC Capital Markets strategist Luis Estrada. He added, "The currency has become 'collateral damage of global portfolio reduction.'"
The real didn't just suffer from external pressure. Brazil's own central bank made things worse.
The bank cut its benchmark interest rate even while signaling that inflation risks are rising. Economists now forecast the Selic rate will end the year at 14%, meaning only one quarter-point cut from current levels. That is still very high, but the mixed message spooked investors.
According to Alejo Czerwonko, UBS Global Wealth Management's chief investment officer for Emerging Markets Americas, "A hawkish Warsh played a role, but a dovish Brazil central bank didn't help the real's case either, "considering Brazil's far from anchored inflation expectations and election-linked fiscal concerns"."
Falling oil prices also hurt. Investors had built up bullish positions in the real during the Iran conflict, expecting energy prices to lift the currency. When oil dropped, they rushed to unwind those bets.
And hopes for a right-wing, market-friendly candidate in Brazil's October election faded, adding to the gloom.
Some economists think the real's plunge has gone too far. Natixis chief Americas economist Benito Berber argues the worst is already reflected in the price.
"Nearly everything that could have gone wrong for the real has, in fact, materialized in recent weeks," Berber said. "A significant amount of negative news has already been priced in."
Several analysts consider the selloff a buying opportunity.
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