Lula's surprise win hits Korean investors in Brazil bonds
A man at a financial company points to a screen displaying market activity in Sao Paulo, Brazil, Monday, following the reelection of President Luiz Inacio Lula da Silva. Reuters-Yonhap
Korean investors who piled into high-yield Brazilian bonds ahead of the country's presidential election are nursing losses after Luiz Inacio Lula da Silva's surprise victory sent bond yields soaring and the currency tumbling, analysts said Wednesday.
Brazilian government bonds have been popular among wealthy Korean investors, offering annual yields of around 10 percent and tax-free interest income under a bilateral tax treaty between Korea and Brazil.
Korean investors purchased a net $5.53 million worth of Brazilian bonds in September, nearly four times the $1.39 million recorded the previous month, according to SEIBro, a data portal operated by the Korea Securities Depository.
They continued to buy Brazilian bonds this month, with net purchases totaling $1.78 million through Tuesday.
Investor sentiment was buoyed by improving market conditions ahead of the presidential election amid growing expectations of a right-wing victory.
However, market sentiment shifted sharply after the election outcome. Growing concerns over increased government spending and a widening fiscal deficit sent government bond yields soaring, driving bond prices lower while the real weakened.
The yield on Brazil's 10-year government bond maturing in January 2035 fell to a 52-week low of 12.5 percent earlier this month before surging to 15.4 percent on Monday (local time). The jump represented an increase of about 2.4 percentage points from the previous trading session, a move estimated to have driven bond prices down by roughly 11 percent.
The real also tumbled, weakening 8.36 percent to 5.406 per U.S. dollar on Monday. Brazil's benchmark Bovespa index plunged 17 percent, posting its biggest decline since the COVID-19 pandemic rattled markets in March 2020.
Korean bond investors now face the risk of suffering losses from both falling bond prices and unfavorable currency movements. Investors who bought Brazilian bonds in October, when the real had strengthened to 4.98 per U.S. dollar, are expected to suffer even steeper losses.
Analysts say further weakness in the Brazilian real and declines in government bond prices are likely in the short term.
"During past left-wing election victories in Brazil, 10-year government bond yields rose by an average of 38 basis points in the month after the runoff, with gains extending over the following three months," said Dean Heo, a fixed-income analyst at Hana Securities.
"Unlike previous elections, when bond prices showed little movement ahead of the runoff, a strong pre-election rally this time could amplify the market fallout."
Still, the sell-off could present a buying opportunity over the medium to long term, analysts said, as a prolonged economic slowdown caused by high interest rates could ease inflationary pressures and revive expectations of interest rate cuts by Brazil's central bank.