Brazilian assets fell sharply yesterday at the market opening in São Paulo as the political uncertainty rose by another notch. The Brazilian real fell more than 7% against the greenback with USD/BRL rising at around 3.3760 compared to Wednesday’s close of 3.1349 after Brazilian newspaper reports about President Michel Temer.
On the equity side, the situation is not bright either as sell-off in Brazilian equities triggered a circuit-breaker that halted trading after futures on the Bovespa crashed 10% at the Thursday open. In one day, the Brazilian stock market erased almost entirely the gains accumulated since the New Year as the Bovespa closed at 61,597 yesterday.
Investors were caught by surprise as the political situation seemed to settling down as the business-friendly Brazilian President successfully managed to ease foreign investors’ concerns. Traders’ panicked reaction sent option’s implied volatility on USD/BRL through the roof with the 1m measure spiking to 24% from 13.5% a day earlier. The 1m 25 delta risk reversal measure, which is the difference between the price of a call and a put, spiked to 5.74%. Despite the fact that Michel tried to reassure markets, financial indicators continued to move in the other direction with treasury yields and CDS exploding.
Investors reacted aggressively to the news therefore we may see a temporary stabilisation of Brazilian assets morning, especially since the global risk-off sentiment is easing with global equities recovering this morning. However, investors are more than accustomed with the Brazilian political landscape and they know that it may take months before an equilibrium may be reached again. Therefore we would remain cautious regarding the BRL’s outlook, even though there will be some opportunities in the short-term.
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