FxWirePro: Political uncertainties keep BRL prospects edgy but valuations signal momentary gains – Trade alternatives (Strangles, Vega neutrals, and ratios)

The political uncertainty lingers in Brazil, yet it has fallen short to prevent the BCB from monetary easing. The BCB cut 100bp the policy rate, and pointed to a deceleration going forward.

The uncertainty also merited a downward revision to 2017 GDP to flat.

Asset prices have behaved rather well in this context, supported by a benevolent external backdrop. At this juncture, we see USDBRL trading in the 3.20-3.30 range in the next days.

As per the short term valuation models of JPM show 3.25 as fair USDBRL range to coincidental risk metrics, including political/credit premium. Indeed, our models also show that political/credit premium is running at 2.3%.

Trade recommendations:

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.

But the resilience of the BRL reflects the broader appetite for carry and local factors. The market is largely pricing in a positive pension reform story and the risks are for weaker FX and higher mid to-long tenor rates in the case of significant dilution or delay.

-1M/+3M vega-neutral calendars in USDBRL to fade the mid-week vol uptick driven by local and NAFTA political noise.

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 3M USDBRL ATM in vega neutral notionals.

Buy USDBRL 1Y ATM vs sell 18M 25D strangle, 1:2 vega.

Buy 2M USDBRL vs. sell 2M USDCLP in 100:120 vega ratios.