The U.S. Donald Trump administration has warned of a '50%' tariff bomb against Brazil, leading to continued tensions between the two countries. Domestic investors who have purchased Brazilian Government Bonds in large quantities, believing the tightening cycle of Brazil's benchmark interest rate is nearing its end, are weighing the prospect of an earlier rate cut against the potential for a plummet in the value of the real.

According to the Korea Securities Depository on the 12th, domestic investors held $315.47 million (about 430 billion won) worth of Brazilian bonds, including Government Bonds, as of the 10th. The amount held increased by 41.9% from $222.25 million (about 300 billion won) at the beginning of this year.

Supporters of Brazilian President Luiz Inácio Lula da Silva burn an effigy of U.S. President Donald Trump, who announced a 50% tariff, during a protest in São Paulo on the 10th (local time). /AP·Yonhap News

Domestic investors have been in 'buying mode' for Brazilian bonds for 20 consecutive months up to this month. Notably, the net buying last month reached $41.55 million (about 57 billion won), the largest monthly amount since March 2017.

This appears to be due to a resurgence in popularity for Brazilian Government Bonds, particularly among high-net-worth individuals. Brazilian Government Bonds offer a high interest revenue yield of about 10% per annum, along with the benefit of tax exemption on interest income under the Korea-Brazil tax agreement.

Investors bought Brazilian Government Bonds because they judged there would be no further rate hikes following last month. The Central Bank of Brazil (BCB) raised the benchmark interest rate by 25 basis points to 15% during its monetary policy meeting in June.

The BCB has controlled the speed of rate hikes after raising the benchmark rate by 100 basis points three times in a row, reducing the increases to 50 basis points in May and 25 basis points in June. Following the June meeting, the BCB stated, 'We will pause the interest rate hike cycle and assess the effects of this policy.'

The exchange rate between the U.S. dollar and the Brazilian real also showed a downward stabilization trend. The real-to-dollar exchange rate has fallen from a peak of 6.73 reals in December last year to around 5.4 reals this month.

In this situation, U.S. President Donald Trump’s 'Brazil hitting' has emerged as a variable. President Trump announced that he would impose a 50% tariff on imports from Brazil starting August 1.

As Trump threatened to impose tariffs, the yield on 10-year Brazilian Government Bonds jumped 50 basis points compared to the low point this month. The real-to-dollar exchange rate also rose by about 2.5%. This indicates that bond prices have fallen and the real has weakened, which is unwelcome news for Brazilian Government Bond investors.

However, many forecasters believe that the yield on Brazilian Government Bonds is likely to trend downward. With Brazilian exports to the U.S. accounting for about 10% of total exports, a reduction in exports due to tariffs could significantly lower economic growth rates. This suggests that the Central Bank of Brazil may return to interest rate cuts sooner to fend off an economic slowdown, allowing Government Bond investors to seek capital gains.

Jeon Byeong-ha, a researcher at NH Investment & Securities, noted, 'In the short term, the market has moved to risk aversion, but from a long-term perspective, the timing of interest rate cuts could be advanced due to the economic slowdown.'

The issue is the exchange rate. Although the exchange rate between the real and the won has not shown significant movement yet, if conflicts deepen between the U.S. and Brazil, foreign investors may exit the Brazilian market, leading to a sharp decline in the value of the real. In the past, it has been the exchange rate rather than interest rates that caused distress to Brazilian Government Bond investors.

Kim Eun-ki, a researcher at Samsung Securities, said, 'If the volatility of the real exchange rate expands for an extended period, it could result in a drop in the value of the real due to the outflow of foreign investors, alongside a rise in long-term Government Bond yields.'

However, Kim pointed out, 'The percentage of foreign investors in the Brazilian market has significantly decreased to around 10%, reducing their influence compared to the past, and since the high tariff rates may not offer significant benefits for the U.S., a compromise is likely to be reached during negotiations.'