BRL: In Brazil, reform optimism has not waned and there is increasing the risk that Temer may not complete his term. USDBRL should move higher as reform optimism wanes. Economic activity should recover and the rate easing cycle is probably over.
Political developments have shifted the balance of risks in favor of a weaker BRL. We expect BRL to depreciate to 3.50 by year-end due to heightened risks to pension reform being passed.
Hence, uphold USDBRL ratio call spreads as Brazilian lira reflects broader appetite amid major uptrend.
Relatively short-tenor (3M and under) tenors are suitable as vol selling targets given the flatness of the vol curve; for instance, 3M 3.20 – 3.10 1*2 USD put/BRL call ratio spreads cost 25bp in premium (spot ref: 3.2986) for a max payout of 322bp, and 60% discounted to outright USD puts.
CLP: USDCLP trades in the middle of the one-year range (640-680) and it can rally towards the lower end of the range if copper prices rally to year-highs as China growth continues to remain stable.
Sell USDCLP 3m NDF: Stay short in USDCLP 3m NDF at 672.85 with the target at 640 (5.1%) and stop above the top end of the range at 684 (-1.65%). The trading horizon is 3 month and it offers a positive carry of 13bp/month.
CLP underperformance should reverse, we remain constructive on EM FX in the coming months on growth momentum, slow policy normalization and continuation of inflows. CLP is the worst performer in EM currencies this year; EM currencies have appreciated on average by 4% whereas USDCLP is trading at the top of the one-year range (640-680).
MXN: The peso has come a long way from its Trump lows and screens overbought and overvalued at current levels, leading our LatAm team to turn underweight recently. The standout feature of the USDMXN vol surface to us is the cheapness of risk-reversals, both vis-à-vis ATM vols and particularly relative to the amount of carry in forwards that allows for carry efficient expressions of bearish directional views or tail risk hedges.
US administration's soft stance on NAFTA, yield-seeking behavior and change in Banxico's policy stance to neutral will support further MXN appreciation.
Hence we think to bid cheap risk-reversals to serve hedging objectives of the tail risk of Trump’s regime. The telling statistic from the graphic is that that the static carry of Delta-hedged vega-neutral 3M 25D skews is a very substantial 2.5 vol pt., near the upper-end of its 2-yr range.