Over the last few days, both Brazilian stocks and the real suffered major losses amid heightened uncertainties about the upcoming presidential elections.
On Monday, the Bovespa index fell 1.78% to 83,307 points. The 1-month implied volatility also edged above the 20% level to 21.85%. Overall, the stock market was only moderately impacted by the local political developments. On the other hand, in the FX market, traders were more nervous against the backdrop of a potential trade war between the two largest economies.
On Monday, the Brazilian real slid 1.54% to its lowest level since December last year as USD/BRL it hit 3.4219. Developments in the option market suggest that traders are buying protection against further depreciation of the real. The 6-month 25-delta risk reversal (the difference between call and put prices) jumped 45bps to 2.3575% amid mounting worries that a less market friendly candidate will take over from Michel Temer in October's general election. Indeed, international investors are always dubious about left-wing candidates. As an indication, CDS rates started to build upside momentum with the 10-Year rates inching up to 272bps, while the 5-year one rose to 169bps.
Given the uncertainty generated by the political situation, investors will most likely stay away from Brazilian assets. In addition, the interest rate differential has narrowed significantly, as it decreased from around 12% in 2017 to around 5.8% today, making carry trade less interesting, especially in such an environment.
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