Global FX: Contemplating a rotation amongst funders; outlook for BRL

Pat Locke (0:03)

Welcome to this week's At Any Rate podcast. My name is Pat Locke. I'm the FX Strategy team based out of New York. With me this week, Meera Chandan, James Nelligan, and Tania Escobedo from our Latam team based out of New York with me. Thanks everybody for joining. Main event this week was the first round of the Brazil election and kind of the major move in Brazilian local markets. So we've got Tania on to get her latest and how much further that can travel.

But otherwise, this week offered, I think, a bit of a reprieve from the rates fall seen over last week. French spread still pretty close to the highs. Energy prices also a bit up mid week around Iran concerns. Both of those helped Eurodollar to visit and revisit the 111 handle a couple of times. But these weren't kind of the multi-sigma moves like we saw last week with EuroSwitch, for example. What's interesting here is I think we're starting to play whether there's more scope for kind of a broader rotation amongst the funders in FX. And so we'll get the latest on that from Meera and James later on in the podcast. From my side, not a lot of other big developments out of the US this week. Had a bit of a quiet spell of data after last week's modest disappointment in payrolls.

FedSpeak over last week seems to have converged around this idea of not much urgency, scaling down the odds of October.

But we do get CPI next week. Early consensus is for a pretty elevated 6.1 on headline, looking like 2.1 on core though. Anything off piece there will have the market not just kind of rethinking what's pricing for October, but also what the outlook is for the December hike as well. Waller at least this week did kind of intimate that that's still very much in the cards. So CPI next week, the next real US specific catalyst for the dollar, where we retain a bullish bias. So with that, I'll kick it over to Tania.

The biggest fireworks and markets this week in our space, again, was Brazil. So interested to hear from you, Tania, where do you see Brazil, VRL going from here? Is there risks of limited follow through kind of like Huff, what we saw earlier in the year there? And then finally, I would ask, just given kind of the enthusiasm around Brazil right now, is that enough to kind of rejuvenate Latam, very more broadly, after a bit of a setback over the last month?

Tania Escobedo (2:23)

Thank you, Pat. So yes, we had elections in Brazil last weekend and there were some surprises. So maybe some quick context for those who have not been following the story too closely. We went into the first round of the vote on October 4th with the majority of the polls indicating that President Alula was most likely to take the lead and on average, surveys gave him around 3 percentage points advantage over Flavio Bolsonaro. So everything was pointing to a tight race, but with a baseline of Alula being the front runner. Now what actually happened was that Flavio Bolsonaro took the lead in the first round, 47% versus 45% for President Alula, and that completely changed the picture because even though it was a very close race indeed, there were about 8% of the votes that went to other candidates, and all of those candidates are more right-leaning. So statistically, Flavio Bolsonaro is likely to get around 2 thirds of those votes versus one third potentially going for Alula. So now mathematically, it has become very difficult for President Alula to turn this thing around. Just this morning, we had very big polls, data full at last, and they are all pointing to a consolidation of Flavio Bolsonaro's lead in this race.

Now, another surprise that I think is relevant came with the composition of Congress. And there, too, the political right had a very strong show. And that is relevant because, one, it confirms that there is a broad support for this political transition, and two, because it decreases the political fragmentation and facilitates the buildup of right-wing coalitions. So, in a scenario where Bolsonaro wins, then this improves the odds for more structural changes on the fiscal front to be approved by the legislative Congress. So, as you would expect, yes, the market adjusted very quickly to this new information. Prediction markets went from 60 to now 86 percent as probabilities for Bolsonaro winning the election. Dollar BRL gapped lower almost 5 percent, just as the markets opened on Monday, and rates rallied more than 100 basis points in the first minutes of trading. So, it was a very big boost in sentiment. In the volatility space, same things, implied volatilities collapsed for the one month, the three month, the forward volatility for the event, for the second round went from, at some point in the past couple of weeks, pricing 3 to 4 percent, break evens to now parking around 1 percent, which tells you that at least in the eyes of investors, the risk or the uncertainty attached to this election has mostly faded. And all evidence point in that direction, but of course we will have to wait until October 25th. Now the big question, of course, is how much is left in this move. So just to give you an idea, we think that there is probably a 2% point drift on confirmation of the result if Bolsonaro wins for $BRL. But more broadly, I think the real story will start to develop post-election. At the moment, we really don't have much details on the economic team or the economic plan of Flavio Bolsonaro.