FxWirePro: Moody’s to provide cushion to Brazilian real – Hedge USD/BRL via put spread ahead of Lula’s decision

We maintain a more bullish stance than consensus on BRL short-term. 2 predominant reasons for outperformance near-term:

1) The significant progress in capital flows associated with the growth boost we expect in 2018 should provide much support to BRL. In particular, corporate USD issuance is likely to increase creating a natural demand for BRL.

2) The BCB has shown that it prefers to maintain USD/BRL within the recent 3.15-3.30 range by signaling an increase or decrease in the amount of FX swaps rolled. The inflation figure pass-through is lower when inflation expectations are anchored (inflation data likely to be announced today), FX stability would continue to help the BCB end its easing cycle. Lower volatility supports high-carry currencies.

Moreover, Moody’s decision likely to raise the outlook for Brazil’s foreign currency rating from negative to stable came a little surprising as BRL had come under intense pressure over the past few days due to the recent political events (arrest of the former President Luiz Inacio Lula da Silva); in particular as the uncertainty about the political future has increased considerably.

The question of who will assume the political leadership of the country next year is wide open. The fact that Lula cannot stand for Presidency in October comes as a relief to the financial markets, but the alternatives are not likely to make the market feel terribly optimistic either. But clearly, there are more optimists still.

On the options market prices for hedging against real depreciation against the US dollar have eased since early February and are even trading at almost the lowest levels since the financial market crisis. We don’t want to be the pessimists at all costs. We too can imagine that following a chaotic election campaign a new government will see the necessity of reforms – above all for a sustainable budget.

But it seems premature to be optimistic. The high uncertainty related to the elections is unlikely to please the FX market over the coming months. As a result, we see further downside risks for BRL in the run-up to the elections.

USDBRL risk-reversals are at pre-GFC lows and realized vols are soft. Monetize a potential grind lower in the spot after this week's Lula decision via ratio USD put spreads and/or RKOs.

Currency Strength Index: FxWirePro's hourly USD spot index is inching towards -82 levels (which is bearish), while articulating (at 11:56 GMT). For more details on the index, please refer below weblink:

http://www.fxwirepro.com/currencyindex.

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