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BRL: Bearish: USDBRL back to 3.40 on a negative Electoral Court (TSE) ruling on the 2014 presidential campaign financing case, which may compromise the Social Security reform. Another round of wrong-doing allegations to President Temer.
Bullish: USDBRL at 3.05 as Brazil approves the Social Security reform and the political backdrop settles.
We stay neutral in the BRL portfolio. The escalation of political uncertainty that followed President Temer’s corruption scandal warrants a neutral stance on the BRL, in our view. The BRL has been range-bound over the last two weeks with the USDBRL trading in a 3.20/3.30 range but we lack conviction on the directionality going forward given the high sensitivity to political swings.
BRL fundamentals have improved in recent quarters but we prefer to stay neutral for the time being.
RV and naked vanilla hedging trades:
The BRL has been stuck between 3.0-3.2 since the end of January and it is now trading at the upper end of the range.
-1M/+3M vega-neutral calendars in USDBRL to fade the mid-week vol uptick driven by local and NAFTA political noise.
Commodity prices that are important to Brazil that have been slumping massively in recent times – sugar (-25%), iron ore (-30%), soybean (-10%), and oil (-14%) - have plunged in last few months, so terms of trade are working against the currency at the moment.
We prefer to stay on the sidelines in USDBRL and see if the upper end of the range (3.20) holds; a break above could see crowded carry positions squeezed.
Sell 1M vs. buy 2M USDBRL ATM in vega neutral notionals.
Buy USDBRL 1Y ATM vs sell 18M 25D strangle, 1:2 vega.
Buy 1M USDBRL vs. sell 1M USDCLP in 100:120 vega ratios.
Buy 2M USDINR 25D RR vs. sell 2M USDBRL 25D RR.
RUB: The key drivers of our bearish RUB view are the concern of commodity headwind and seasonally weaker current account outlook over the summer. We are more cautious of the commodity exporter, as terms of trade are unlikely to be favorable for RUB as oil prices remain weak. Together with any potential return of generalized financial market volatility in the coming months, the effect will manifest itself in heightened volatility of RUB.
We recommend buying RUB vol via USDRUB at the money call options. Directionally, we think RUB is vulnerable to weakening over the summer as the current account seasonally deteriorates, and hold UW RUB in the GBI-EM Model Portfolio.
The CBR remains s dovish. We expect the measured pace of rate cuts beginning in June. May CPI at 4.1% oya surprised on the upside and is marginally above the inflation target of 4.0%. As our base case, JPM forecasts the CBR to begin its measured rate cuts beginning in June by 25bp with a chance of 50bp rate cut. By the end of 2017, we expect the policy rate to fall to 8.5% from 9.25% currently. We think there is also a possibility that the CBR may accumulate FX reserves on its own account should RUB remain over-valued in their view.
