Low Volatility Revives Latin American Carry Trade, Brazil and Colombia Lead Emerging Markets

With emerging market currency volatility falling to its lowest level since the beginning of the year, carry trades are once again showing strength, with Latin America becoming investors' top destination due to its high expected returns.

Latin American currencies are increasingly seen as the most attractive investment targets in emerging markets, thanks to interest rates that generally exceed those of most developed nations and strong performance on the 'carry risk ratio' metric.

Latin American currencies have led the pack in carry trade performance this year. A strategy of borrowing U.S. dollars and buying Colombian pesos has yielded returns as high as 21%; the Brazilian real and Argentine peso have returned 12.7% and 12.6%, respectively. In contrast, buying Polish zloty, Indonesian rupiah, or Thai baht has resulted in losses of at least 5%.

Additionally, as Middle East conflicts escalate, Brent crude oil prices recently surged past $90 per barrel. ING Bank notes that, since many Latin American countries are oil exporters, they are better insulated against energy price shocks compared to regions such as Europe, Middle East, and Africa (EMEA) or Asia. This low-volatility environment is attracting capital flows to areas less affected by such shocks.

In the key metric for measuring carry trade attractiveness—the carry risk ratio—the Brazilian real ranks first among Bloomberg’s list of 27 currencies with a score of 1.33, while the Colombian peso ranks third with 1.31, and the Mexican peso fifth.

Wall Street giants such as JPMorgan and Citibank have recently voiced support for high-yield currencies. Citibank recommends clients go long on a basket of Brazilian, Colombian, Mexican, and Turkish currencies. JPMorgan, citing Colombia’s position among the highest real interest rates in Latin America, has upgraded its rating to 'overweight'.

However, this revival is not without risks. Edwin Gutierrez, a sovereign debt expert at Aberdeen, warns that election uncertainties in Brazil and Colombia, along with concerns over fiscal consolidation paths, require caution. Moreover, the potential economic threats posed by 'El Niño' to Andean nations such as Chile, Peru, and Colombia remain a significant factor that cannot be ignored.