The economic outlooks for Brazil and Argentina are significantly better for 2017, but political developments will likely remain fluid.

For now, we reload longs in BRL risk driven by following factors. The BRL slipped around 6.8% against the USD on the month.

Firstly, positioning has improved (refer above diagram). International investors’ long USD positioning is close to YTD highs in the futures, while local institutional investors also scaled back long BRL.

Second, the short-term valuation models suggest a fairly priced USDBRL to coincident risk indicators.

Third, BCB suggested an acceleration of the easing cycle as Q3 activity continues to depict negative momentum. we have argued although the interest rate differential will be lower going forward, real ex-ante rates (when controlling for country risk) are still significantly above rates versus Brazil’s peers.

Finally, although Brazilian political risk is still lingering, we slightly fade the recent spike in political risk.

We believe the government will be able to navigate the daring waters, although we acknowledge the risk of the second spending cap vote being delayed into next year.

Thus, we go long BRL RV via long BRL/COP (Target: 950, Stop: 860). We also see this as a carry efficient way to short COP.

At the same time, the BRL vol curve has mildly inverted in 1M – 3M expiries such that it has become economically viable to sell gamma hedged with vega longs via vega-neutral short 1M vs. long 3M straddle calendar spreads.

Directional investors not given to 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 3.40 strike USD call/BRL put one-touch calendars cost a net premium of 16% on mid (equal notional/leg). Assuming unchanged markets in a month’s time, the 1M 3.40 expires worthless and the 2M 3.40 rolls up to 40%, resulting in an acceptable static carry/payout ratio of 2.5 times.