Before we begin with this write-up, we urge you to glance through BRICS currencies against the dollar; you notice a massive depreciation in BRICS pair from last 3-4 days to trade 4-weeks highs.

EM currency performance was manifestly poor towards the end of last week. What’s interesting is that those EM currencies with the highest real rates were the ones with the largest total return losses (see above chart).

This is strange; those currencies with the highest real yields should have performed relatively well. Especially the likes of BRL and RUB, where we see large improvements in external balances / current accounts.

Clearly, we are seeing a correlation breakdown with the market doubting the ‘lower for longer / lower forever’ Fed rate stance will continue.

Essentially, those currencies which benefitted purely from a ‘carry’ perspective are under pressure now because

1) Volatility increased and

2) Markets doubt that the carry differential will persist in the coming months / years.

It could well be the case that this is an over-reaction to last week’s US election. But one thing is clear: any EM central bank which even hints at cutting interest rates is inviting trouble.

It also shows that BCB were absolutely correct in having a back loaded rather than front-loaded rate cutting cycle.

Directional investors not given to active delta-hedging can consider buying calendar spreads of USD call/BRL put one-touch options instead of straddles.

For instance, short 1M vs. long 2M 3.42strike USD call/BRL put one-touch calendars cost a net premium of - 16% on mid (equal USD notionals/leg) and roll up to - 45% in a month’s time assuming unchanged markets, resulting in a static carry / payout ratio of 2.9X.  

USDZAR remains about 2% too low in our models. Amid continued upside pressure on G3 yields, we view the currency as a good vehicle for protection against generalized EM FX weakness and stay UW in the GBI-EM Model Portfolio.

After the disappointing budget presentation this week, near-term sovereign ratings downgrades remain highly likely, in our view (South Africa: MTBPS credible but underwhelming, firming ratings downgrade view).

We sell 3M USDINR against our long 1Y EUR/INR, and 2M USD/SGD vs our long 6M, all in vega neutral amounts.