Even though the high-yielding currencies have become consensus trades for 2018, it is maintained a more bullish stance than consensus on BRL short-term. In 2018, EMFX space relies more on carry for returns. However, the valuations aren’t yet demanding and the growth backdrop offsets gradual Fed rate hikes. Owning protection on BRL is preferred given positioning and political risks.
Predominantly, 3 reasons are foreseen for outperformance in the near-term:
1) The significant improvement in capital flows linked to the growth boost we expect in 2018 should provide much support to BRL.
2) With the SSR out of the market’s mind, we believe it will next focus on Lula’s appeal. On January 24th, we suspect that the most likely scenario will be for the TRF4 to upheld former president Lula’s conviction unanimously, which could lead to BRL rallying as this could open the door for more market-friendly candidates to join the presidential election race.
3) Corporate USD issuance is typically large in January ($6bn, refer above chart), creating a natural demand for BRL. We estimate that roughly half of the USD issuance could be converted into local currency, creating $3bn of BRL inflow.
Options recommendation: As we can observe that the underlying spot FX trend has been stuck in the range that’s long lasting and contemplating above mentioned fundamental driving forces, we see opportunities in below options strategy.
Short 3M vs long 6M delta-hedged USDBRL straddles vega neutral. This isn’t hard and fast, we can customize based on the need and potentiality.