Latin American Markets: High Carry Returns Now Face Soaring Asymmetry Risk – BNY Analysis

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Latin American Markets: High Carry Returns Now Face Soaring Asymmetry Risk – BNY Analysis

Financial analysts at BNY Mellon have issued a critical assessment of Latin American (LatAm) financial markets, highlighting a compelling yet precarious dynamic for global investors in early 2025. According to their research, the region continues to offer attractive high-carry returns, but these are now increasingly shadowed by what the bank terms ‘rising asymmetry risk,’ a scenario where potential losses could disproportionately outweigh gains. This analysis, grounded in recent macroeconomic data and currency volatility metrics, presents a nuanced picture for portfolios with exposure to emerging markets.

Understanding the LatAm High-Carry Proposition

The term ‘carry’ in finance refers to the return earned from holding a higher-yielding asset, often funded by borrowing in a lower-yielding currency. For years, Latin American economies, particularly Brazil, Mexico, and Colombia, have offered some of the world’s highest real interest rates. Consequently, global investors have been drawn to local currency bonds and other interest-bearing assets. The International Monetary Fund (IMF) notes that, despite global monetary tightening, several LatAm central banks were among the first to hike rates, creating a sustained yield differential.

This environment has generated significant income for carry trade strategies. For instance, the Brazilian real and Mexican peso have been perennial favorites in this space. However, BNY’s analysis suggests the fundamental appeal of this carry is undergoing a stress test. The bank points to shifting global liquidity conditions and domestic political cycles as primary catalysts for change.

The Mechanics of Carry in Volatile Markets

Carry trades profit from stability. Investors borrow in a low-yield currency like the Japanese yen or Swiss franc, convert the proceeds into a high-yield LatAm currency, and invest in local government bonds. The profit is the difference between the earned interest and the funding cost. Nevertheless, this strategy faces immediate jeopardy if the high-yield currency depreciates sharply against the funding currency. A sudden 5% devaluation can wipe out a year’s worth of carry income, hence the focus on ‘asymmetry.’

Decoding the Rising Asymmetry Risk

BNY Mellon defines ‘asymmetry risk’ as the growing probability of large, negative price movements that are not matched by equivalent upside potential. In essence, the risk-reward profile is becoming skewed. The bank identifies three converging factors driving this asymmetry in Latin America:

• Commodity Dependency Shocks: Many LatAm economies remain heavily tied to global commodity prices (e.g., copper for Chile, oil for Colombia, soy for Argentina). The 2024-2025 global growth slowdown has introduced heightened volatility in these markets, directly impacting trade balances and currency stability.
• Political and Fiscal Uncertainty: Key nations are navigating complex political landscapes. Market-sensitive reforms, fiscal deficits, and social spending pressures create unpredictable policy environments. This uncertainty can trigger rapid capital outflows.
• External Financial Conditions: The monetary policy path of the U.S. Federal Reserve remains a dominant external force. While the peak of the hiking cycle may have passed, the timing and pace of any easing is uncertain. Tighter-than-expected U.S. policy can swiftly reverse capital flows to emerging markets.

This combination means that while the daily ‘carry’ income ticks positively, the latent risk of a significant, correlated downturn across regional assets has increased. The potential loss from such a downturn could far exceed the cumulative carry earned over many months.

Comparative Market Analysis and Data Evidence

BNY’s report includes comparative data illustrating this shift. The following table summarizes key risk indicators for major LatAm currencies as analyzed in Q4 2024:

The ‘skew risk indicator’ is particularly telling. A negative skew in options pricing reflects the market’s willingness to pay more for protection against a sudden drop than for a potential rally, directly quantifying the asymmetry BNY highlights. Data from regional central banks and the Bank for International Settlements (BIS) corroborates an increase in these hedging costs.

Expert Perspectives and Portfolio Implications

Market strategists cited in the analysis recommend a more selective and hedged approach. The era of ‘pure’ unhedged carry trades in LatAm may be fading. Instead, investors are increasingly looking at relative value trades between countries, currency-hedged bond positions, or combining carry with explicit options strategies to truncate downside risk. The core insight is that the free lunch of high, stable carry is over; the yield now comes with an explicit and rising insurance premium.

Furthermore, the differentiation between countries is becoming more critical. Nations with stronger institutional frameworks, lower fiscal deficits, and credible inflation-targeting regimes are likely to exhibit less asymmetry. Investors must now conduct deeper fundamental analysis rather than relying on broad regional yield averages.

The Global Macro Context

This LatAm dynamic does not exist in a vacuum. It reflects a broader global shift where excess liquidity is receding, making all financial assets more sensitive to idiosyncratic risks. The BNY analysis serves as a case study for other high-carry emerging markets. It underscores a fundamental principle in 2025’s investment landscape: in a fragmented global economy, yield must be constantly evaluated against the structural and cyclical risks that can rapidly erase it.

Conclusion

The BNY Mellon analysis presents a crucial update for anyone monitoring Latin American markets. The region’s high-carry characteristic remains intact, offering yield in a yield-starved world. However, this return is now guarded by a significant and growing wall of asymmetry risk, where the potential for abrupt, correlated losses has increased. For investors, this necessitates a strategic shift from passive income harvesting to active risk management. Success in these markets will depend on rigorous country selection, sophisticated hedging, and a keen eye on the interplay between local politics, commodity cycles, and global capital flows. The LatAm carry trade, while still alive, now demands a much higher price for admission.

FAQs

Q1: What is a ‘carry trade’ in the context of Latin American markets?
A carry trade involves borrowing in a currency with low interest rates to invest in a currency with higher rates. In LatAm, investors often borrow in currencies like the JPY or USD to invest in high-yielding assets in Brazil, Mexico, or Colombia, profiting from the interest rate differential.

Q2: What does ‘asymmetry risk’ mean?
Asymmetry risk refers to a scenario where the potential for losses in an investment is significantly greater than the potential for gains. In this case, a sudden currency devaluation or market shock in LatAm could wipe out years of accumulated carry income, creating a skewed, unfavorable risk-reward profile.

Q3: Which Latin American countries are most cited for high carry?
Brazil and Colombia have traditionally offered some of the highest real interest rates. Mexico also offers attractive yields, often with perceived lower volatility due to its tighter integration with the U.S. economy.

Q4: What are the main drivers of the rising asymmetry risk according to BNY?
BNY identifies three key drivers: increased volatility from commodity price shocks, domestic political and fiscal uncertainty, and tightening external financial conditions, primarily from U.S. monetary policy.

Q5: How are investors adapting to this new risk environment?
Investors are moving towards more hedged positions, using currency options to protect against downside, focusing on relative value trades between countries, and applying much stricter fundamental analysis to differentiate between nations with stronger and weaker economic fundamentals.

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