FxWirePro: Umpteen reasons for BCB to be hawkish, handful to be dovish though – RV options trades to hedge BRL

The Brazilian central bank (BCB) holds monetary policy meeting tonight and would decide on its key rate. Well, there’ve been a couple of factors that prompt for a further rate cut but also reasons for a pause.

Moderate inflation is pointing towards a rate cut; at 2.8% it remained below the central bank’s target corridor of 3-6% in February.

The central bank is surprised about the continued moderate inflation levels. Due to the slow economic recovery that is likely to remain the case. The pension reform, which has been put on ice, for now, points towards a pause though. In its monetary policy statements, the BCB had always referred to the importance of political reform for the long-term inflation development. On the other hand, BRL hardly showed any reaction at all to the news that a decision on the pension reform, that is very important for fiscal consolidation, was going to be postponed indefinitely.

After all the reform is not completely off the agenda yet and might be put back on track following the Presidential elections in October. That means that despite the fact that at its last meeting in early February the central bank signaled a rate pause it might use the opportunity and cut interest rates again as a result of the favorable framework conditions (low inflation, stable BRL). The decision is unlikely to put notable pressure on BRL as the central bank has gained a high degree of credibility over the past years.

Trade tips:

On daily charts, we see stiff resistance at around 3.3170 - 3.3346 levels where the pair has shown a convincing supply zone in the recent history.

Crucially, the historical performance of delta-hedged 3M BRLJPY-USDBRL straddles shows the vol spread generates its biggest returns during major market downturns, rendering the spread a cost-efficient low bleed blow-up hedge from entry levels that are rarely witnessed.

At current markets, OTM BRL calls offer about 0.5 vol edge over ATM strikes prompting us to favor 6M 25 delta long BRL calls /JPY puts  @ 11.6/12.2 vs. short USD puts / BRL calls @11.65 choice, in equal vega notionals; the choice of longer (6M) expiry is intended to buy more time for a potential vol eruption to materialize.

FxWirePro launches Absolute Return Managed Program. For more details, visit: 

http://www.fxwirepro.com/invest