Bloomberg News

Japanese Withdrawals Deepening Tumble in Real: Brazil Credit

September 30, 2011

Sept. 30 (Bloomberg) -- Japanese investors, who hold $102 billion worth of Brazilian assets, are pulling the most money out of the Latin American country’s currency market since April, deepening a slide in the real that’s fueling bond losses.

Pensioners and other individual investors took 52.7 billion yen ($689 million) out of so-called currency overlay funds that speculate on the real this month through yesterday, according to data compiled by JPMorgan Chase & Co. The 16.8 percent drop in the real in the past three months, the second-worst performance among all currencies tracked by Bloomberg after the Polish zloty, handed local bond investors a 10.5 percent loss in dollar terms, according to JPMorgan Indexes.

Japanese investors are exiting Brazil’s foreign-exchange market as the central bank cuts interest rates while inflation quickens and as Europe’s debt crisis fuels concern the global economy will sink into recession. Japanese mutual funds had boosted their investment in the currency, stocks and bonds of Latin America’s biggest economy to 7.9 trillion yen at the end of August from less than 1 trillion yen in 2009, according to data compiled by Nomura Holdings Inc.

“We are seeing signs that the Japanese investors are leaving and it’s very significant because the size of their investment is huge,” Mauricio Junqueira, who helps manage about $300 million at Squanto Investimentos in Sao Paulo, said in a telephone interview. “Even a 10 percent outflow will cause pretty important changes in the real.”

Global Recession

The losses in real-denominated bonds in the past three months compared with an average decline of 8.6 percent among emerging-market debt, according to JPMorgan. While a rally in Brazilian bonds drove down yields on benchmark securities due 2021 by 86 basis points, or 0.86 percentage point, to 11.62 percent in the third quarter, the real’s slump wiped out investors’ returns in dollars.

The real touched a two-year low of 1.9549 per dollar on Sept. 22, prompting the central bank to step into the futures market for the first time in two years to stem losses. The currency sank 20.4 percent against the yen, erasing all the gains since March 2009. All 25 emerging-market currencies except the Chinese yuan fell against the dollar since the end of June.

International investors expect the world economy to relapse into a recession, according to a Bloomberg poll conducted Sept. 26. About two-thirds of those surveyed say the international economy is deteriorating, up from just 18 percent who felt that way in the last poll, in May.

Surprise Cut

Japan’s overlay funds held about $40 billion in non- deliverable forwards, which is the equivalent of about 13 percent of Brazil’s foreign reserves, according to JPMorgan’s currency strategists Junya Tanase and Anna Hibino. Investors withdrew 71 billion yen from the overlay funds in April after an earthquake and tsunami in Japan left about 19,000 people dead or missing and caused the worst nuclear crisis since Chernobyl.

The overlay funds buy currencies including the real and Australian dollar in addition to investing in high-yielding securities such as non-investment-grade U.S. corporate debt to boost returns. Japanese banks sold the first real overlay funds to retail investors in early 2009.

The real’s plunge deepened after the central bank unexpectedly lowered its benchmark interest rate a half- percentage point to 12 percent on Aug. 31 even as inflation quickened to a six-year high. Consumer prices rose 7.33 percent in the year through mid-September, exceeding the upper limit of the government’s target range for a fifth straight month.

‘Another Layer’

Finance Minister Guido Mantega, speaking in Brasilia a day after the rate cut, called the move an “antidote” to weaken the real after it rallied 46 percent since the end of 2008, crimping exports. The government has also imposed a tax on currency derivatives and restricted foreign borrowing from companies this year to halt the rally, which sent the real to a 12-year high of 1.529 per dollar on July 26. It fell 2.1 percent today to 1.8794.

“The problem with the Brazilian market is that there’s a lot going on at the same time,” Flavia Cattan-Naslausky, a strategist at RBS Securities Inc., said in a telephone interview from Stamford, Connecticut. The retreat of Japanese investors would “provide another layer of volatility and price correction,” she said.

More than 70 percent of the Japanese investors in overlay funds are retirees at least 60 years old, according to Nomura, the largest brokerage firm in Japan. Investors are unlikely to step up redemptions because the monthly payments they receive from the funds aren’t affected by the day-to-day swings in global financial markets, said Yujiro Goto, a currency strategist at Nomura in New York. Yields on Brazilian real forwards contracts are still attractive, he said.

‘Not Rushing’

At 8.2 percent, three-month implied yields on the real’s non-deliverable forwards are the third highest among 38 currencies tracked by Bloomberg.

“They are not rushing into selling,” Goto said in a telephone interview. “They can take more financial risk.”

The yield on overnight interest-rate futures contracts due in January 2012 fell 10 basis points to 11.08 percent, indicating the central bank will lower borrowing costs by about 125 basis points to 10.75 percent, according to data compiled by Bloomberg.

The extra yield investors demand to own Brazilian government dollar bonds instead of U.S. Treasuries rose five basis points to 276, according to JPMorgan.

The cost of protecting Brazilian bonds against default rose 14 basis points to 202, according to CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market. Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent if a government or company fails to adhere to its debt agreements.

More Withdrawals

About 1.6 million Japanese nationals or people of Japanese descent live in Brazil, the biggest community outside of the Asian country, according to the country’s embassy in Brasilia. Japanese started to immigrate to the South American nation in the early 20th century as laborers working in coffee plantations.

JPMorgan’s strategists said Japanese investors in overlay funds may pull more money out of Brazil after the real dropped to a two-year low versus the yen and the Nikkei index of Japanese stocks, a gauge of demand for higher-yielding assets, fell below 8,700.

“Since some invest in overlay funds specifically because they want to gain exposure to that currency, they may be more sensitive to currency movements,” Tokyo-based Tanase and Hibino said in an e-mail. “The impact of large unwinding of real overlay funds would be significant.”

--With assistance from Andre Soliani and Maria Rabello in Brasilia. Editors: Lester Pimentel, David Papadopoulos

To contact the reporters on this story: Ye Xie in New York at

To contact the editors responsible for this story: David Papadopoulos at;

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