FxWirePro: Brazil Q3 GDP print unlikely to cushion real – Uphold ratio put spreads for optimized hedging

Brazilian Q3 GDP data would be published today. In line with consensus, we expect a growth rate of 0.3% QoQ (seasonally adjusted). What is going to be of particular interest is the development of investments.

While private consumption turned positive in Q2, capital investments once again recorded negative QoQ growth. Should we see signs for a recovery also in this sector, the recovery of the overall economy is likely to gain traction.

However, the effect of today’s publication on BRL is likely to be limited. Instead, attention is likely to focus on news surrounding the progress of the pension reform. It had originally been planned that the lower chamber was going to vote on the reform for the first time.

However, yesterday there were reports that the vote may be postponed by a week or even until early next year. We are skeptical anyway as far as the vote and the adoption of the reform are concerned and expect BRL to come under pressure against USD over the coming months.

Options strategy:

BRL has underperformed other EM FX, screens cheap on short-term valuation models and spec FX positioning (basis IMMs) at their lowest in a year, prompting an upgrade to OW in the GBI EM portfolio. Even if the hawkish shift in G7 central bank rhetoric prevents full mean-reversion in spot to pre-tape bomb spot levels, we think there is a case here for considering low premium, bullish structures such as 1*2 USD put/BRL call spreads that take advantage of the healthy 3 vol+ implied – realized vol spread and the relative richness of the USD put skew on the surface without selling the undefined political tail.

Relatively short-tenor (3M and under) tenors are suitable as vol selling targets given the flatness of the vol curve; for instance, 3M 3.35 – 3.10 1*2 USD put/BRL call ratio spreads cost 25bp in premium (spot  ref: 3.2722) for a max payout of 322bp, and 70% discounted to outright USD puts.