Off late retracements in USD versus emerging market currencies looks overdone, but BRL will likely underperform on any risk-off event. We foresee BRL as one of the most vulnerable currencies because of looming idiosyncratic risks.

Brazil is running the highest real interest rate in the world. Furthermore, debt to GDP is amongst the highest across EM.

While, The Brazilian GDP shrank 1.7% on quarter in the last three months to September of 2015, worse than market projections. It is the 3rd consecutive contraction in a row as investment shrank for the 9th straight quarter and household spending posted the third consecutive fall.

The combination of high real interest rates, negative growth and rising debt to GDP puts Brazil in similar debt dynamics to those observed in Greece back in 2010. The main difference between Brazil now and Greece in 2010 is that Brazil can monetize. In other words, unlike Greece, Brazil can print its own currency to service its local debt.

This could very well be one of the solutions to improve the fiscal outlook. Higher inflation could reduce as much as a third of the domestic debt market, which is not linked to inflation and has reasonably long-dated tenors.

We continue to carry bullish attitude in USDBRL and would eye in buying dips within the range. The 3.8400 range lows provide nearby support. Our initial upside targets are toward the 4.0470 area. Beyond there would signal further upside toward the greater range highs near 4.1720 and then the 4.2480 2015 peak.

We recommend going long USDBRL in 1M (1.5%) in the money 0.71 delta call and simultaneously short 2W (2.5%) out of the money call with positive theta and delta closer to zero for net debit, as the recent retracement in USD versus emerging market currencies looks overdone and BRL will likely underperform on any risk-off event. We view BRL as one of the most vulnerable currencies because of looming idiosyncratic risks.