Brazil negative basis turns positive

Unlike the sometimes lucrative negative basis trades that are sought after in corporate credit markets, such as the recently highlighted Tyson Foods example, negative basis’ are/have been the norm in some sovereign names at different times.

Bloomberg reported earlier this week the reversal of a 3-year average 6 bps small negative basis trade in Brazil that just turned positive.

“ ‘In the global search for yields, there has been a huge inflow into emerging-market fixed income assets……There’s been a record amount of fund inflows from long-only investors that want to own cash bonds as opposed to derivatives, such as CDS. It could be a new normal as long as interest rates globally remain low.’

The extra yield investors demand to hold Brazilian five- year dollar bonds instead of U.S. rates fell to 107 basis points, or 1.07 percentage points, yesterday, according to data compiled by Bloomberg. The difference, known as the Z-spread, was 11 basis points below the country’s five-year credit-default swaps, near the most in four months. That’s a reversal of the three-year average in which the default swaps were six basis points lower than the Z-spread

Default swaps are usually lower than bond spreads because they are more actively traded and require less cash to invest in. Demand for cash assets is reducing the “liquidity premium” in bonds over swaps….. Brazil’s bond spreads jumped to a record 88 basis points over the default swaps in December 2008 when the global financial crisis eroded demand for emerging-market debt.

The average yield on Brazilian dollar bonds over U.S. Treasuries narrowed 39 basis points in the past three months to 202, compared with the record low of 138 set in June 2007, according to JPMorgan Chase & Co.’s EMBI+ index. The average overall yield on the bonds has declined 89 basis points over that time to 4.94 percent.”

Investors appear to be ploughing into Brazilian bonds in similar manner to the way they have been buying US Treasuries. The negative-to-positive basis reversal is not just limited to Brazil either. Columbia and Mexico have also seen a similar phenomenon.