Opinion – Helio Beltrão: ‘Carry trade’ favors the real, which performs well in 2022

Even after the dollar’s rise this week, the real remains in the lead among the best performing emerging currencies in 2022. That’s good news.

Contrary to what hardened developmentalists claim, a deliberate policy of devaluation of the national currency is incapable of generating prosperity for the country as a whole. On the contrary, the common citizen loses purchasing power, and the country becomes poorer in hard currency. Ask a citizen of Venezuela, Zimbabwe, or even Argentina or Turkey…

It is, therefore, positive that the real has found an anchor again, a reflection of the recent attitude of the Central Bank, which abandoned its inflationary policy of negative real interest rates (Selic below inflation). After a long period of complacency with inflation, the Central Bank should raise the Selic rate this Wednesday (16th) to 11.75% or 12%, positioning short-term interest rates firmly above the IPCA, which has been running above 10% year for months in a row.

Much worse than higher interest rates is the erosion of the population’s wages and savings by uncontrolled inflation.

This year, Brazil was once again one of the favorites for the “carry trade”, a powerful mechanism for trading international capital that rewards currencies with good prospects and sound monetary policies. The forex (currency exchange) market is the largest in the world, with daily volume in excess of $5 trillion (or about $2 quadrillion a year, nearly 100 times the GDP of the United States). A good part of these negotiations is “carry trade”.

In the carry trade, an investor borrows money in a low-interest currency, or funding currency (e.g., the dollar, euro, yen), and invests in a currency whose bonds pay high interest (target currency). ). When the bond matures, the investor converts its proceeds back into the funding currency and repays the loan. The investor’s profit is the difference between the interest received on the bond and the interest paid on the loan.

According to the traditional theory of finance (“interest parity”), the expected profit from this strategy should be zero, as the expected devaluation of the target currency equalizes the interest received and the interest paid. In other words, the higher interest earned in the target currency only reflects its higher risk of devaluation. But the consistent track record of profits realized by the carry trade strategy continues to challenge traditional theory.

The “carry trade” has turned to the real because there is a clear divergence between the policies of the BC and other central banks. The BC acted first and already has interest rates above inflation (about 6% real interest for a period of one year). The Fed and the European Central Bank are only now moving to timidly raise their interest rates, which, in turn, will remain below inflation for quite a long time.

Many mistakenly criticize the “carry trade” for being skittish and only providing short-term capital. But capital is capital, and its benefits in strengthening the currency when fundamentals are good are undeniable.

Every country has the interest rate it deserves, which reflects the (ir)responsibility of its fiscal and monetary policies. A country that is deficient in creating and maintaining national capital needs to have as much capital as possible over time. By setting unrealistically low rates and promoting inflation, a central bank drives away foreign and domestic capital, which carries with it the potential for job and income growth.

When sensible monetary policies are in place as they are now, inflation tends to drop, the carry trade strengthens the national currency, and long-term capital returns. At least, of course, until the next crisis.