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Macro and Vol Commentary

Inflation in Brazil continues to increase but will the rate hikes strengthen the BRL?

Economic Data

  • GDP rebounded strongly in Q2 to 12.4% Y/Y, however, it is worth remembering how the economy was performing in Q2 2020. The last 4 quarters accumulated GDP was 1.8% in Q2, and the Q/Q performance showed a modest contraction in Q2 2021, by -0.1%.
    • Real GDP was back to pre-pandemic levels in Q1 2021 and has continued to push higher since.
  • The IHS manufacturing PMI declined in August to 53.6, output growth was the slowest since May as supply chain bottlenecks and shortages prevented raw materials from reaching manufacturers.
    • This prevented significant business growth and export orders declined for the 1st time in seven months.
    • Real depreciation and higher raw material prices caused higher selling charges and input shortages.
    • The real has strengthened marginally since but inflation remains high; optimism is improving and we expect a similar reading next month.
  • Markit Brazil PMI composite and services are also expanding, reaching 54.6 and 55.1 in August, respectively. However, composite PMI was lower than the previous month, which was 55.2, compared to services which improved from 54.4 in July.
  • Industrial production declined on M/M basis in July at -1.3%, and 1.2% Y/Y. We expect a similar story as with manufacturing: accessing the raw material, supply chain bottlenecks and high freight prices are preventing industrial production to rise.
  • Retail sales are improving and stand at 5.7% Y/Y and 1.2% M/M in July. Inflation remains a problem, and the high levels of unemployment continue to plague consumer demand.
  • The number of unemployed was 14.4m in Q2, this was a drop of 0.6% and the unemployment rate is at 14.1%.
    • According to the latest data, 32.2m people are either out of work or not working as many hours as they used to.
    • We expect to see the labour market improve in Q3 and Q4 2021 as the economy creates more jobs, but things are far from ideal.
    • Wages remain stagnant, with the average monthly salary for new hires at BRL1,801.9 in July
    • The number of workers who have given up searching for jobs declined in Q2 by 6.5%.
  • Inflation continues to rise, with the IBGE inflation at 9.68% in August, beating expectations. The M/M rate was slower at 0.87%.
    • The IBGE inflation rate saw the transportation component up by 1.5% M/M, with new and used cars up 1.8% and 2% M/M, respectively. Gasoline prices were up 2.8% M/M as well.
    • Food at home was +1.4% M/M, we expect the inflation dynamic to worsen in the near term but then start to decrease next year, we expect to see inflation break 10% in September.
    • The cost of electricity is another major factor, Brazil uses hydroelectricity for 65% of its energy generation. There has been a significant drought in the country, increasing the cost of electricity.
    • The FGV CPI rate increased by 0.91% on September 7th, the inflation expectations are not letting up.
  • The trade balance was $673m in the week to September 5th.
  • The monthly trade balance was $7.665m in August, exports totalled $27,212m with imports $19,547m which is down on the previous month.
    • The strong export number was in spite of the high freight prices and supply chain bottlenecks.
    • High exports will benefit the economy which has levels of debt.
  • Brazil public net debt has consolidated in recent months and stood at 60.3% in July 2021, down from 65% in December 2020. Public debt stands at 84%, which is high.
    • Brazil’s 10 yr yield has rallied in recent weeks and now stands at 11%. The political instability in conjunction with high inflation expectations, and therefore higher rates, have caused yields to weaken.
    • There is a large amount of debt with short maturity, making it unattractive and this could compound the issue for the economy.

Monetary Policy

  • Due to inflation beating expectations, we now expect a larger than expected rate hike on September 22nd. We could see a 100bps increase in the Selic rate, with the probability of a larger rate hike significant.
  • This will be followed by further rate hikes of 100bps before reaching 9.5%, we increase our expectations of the Selic rate at year-end from 7.5% to 9.5% in Q1 2022.
  • The BRL should rally off the back of this news; however, a lot of this will now be priced in, indeed quickening the pace reduces the credibility of rate hikes.

The economy is growing but at a slow rate, and this is not going to turn around in the near term as supply-chain fragilities and high freight prices are impacting exports. However, the economy did manage to export more goods in August than in July. A large issue for the economy is high levels of unemployment, increasing inflation, and large public debt. Consumers spending is weaker as a result and weekly earnings are low at this time. We do see the unemployment rate declining in the coming months as new job openings are becoming available, however, with inflation high, spending power is diminished. The manufacturing sector is showing signs of resilience but the political uncertainty surrounding Bolsonaro and the Supreme court has worried foreign investors and this caused money to be taken out of Brazilian stocks; which continue to underperform global peers, and the BRL to weaken. The faster than expected rate hikes should support the BRL in the near term but we previously saw the BRL sell off when rates were increased suggesting lack of appetite for the Brazilian currency. GDP remains sluggish and with rates rising, confidence low and the USD stabilising, the BRL could suffer in the medium term. We favour trading the 5.10 – 5.40 range. The BRL strengthening remains a viable trade but the days are numbered as the downside risks continue to stack up.

Volatility Commentary

Over the last few months, we have seen volatility realise mostly in line with implied vols. Short-dated vols (e.g 1 month) are still trading higher than the pre-pandemic levels, vs G10 FX vols which are largely now at pre-pandemic levels. With the economic recovery still being fragile in Brazil, we favour long option positions and, as per the above, see potential for immediate term declines, BRL strengthening and medium-term BRL weakening and would suggest the below structure to benefit from these spot moves.

USDBRL 1-month Implied and Realised Volatility

USDBRL Trade Idea

  • Buy 3-month KI USDBRL Call Option, priced in 10m USD Notional with 5.26 strike at 5.15 lower KI barrier has cost circa 180k USD
    For reference, a vanilla 5.26 strike equivalent has a cost of circa 400k USD

Positioning Charts

USDBRL NDO Positioning Data 01/09/2021 - 08/09/2021

Options executed in the week to September 15th shows a mixed outlook. Trades are scattered around 5.20 with few options for expiry for this week and the range is significantly wider than the previous week. Options due to expire soon have a small notional. We expect the market to edge lower in the near term but the market indicates there is little conviction. 

USDBRL NDO Positioning Data 08/09/2021 - 15/09/2021

USDCNY Vanilla Positioning Data 01/09/2021 - 08/09/2021

Volumes traded this week have increased with more preference for the downside. Put options have a wider range down to 6.30 and larger volumes with higher nationals suggesting we could see spot decline. There is little upside cover but the majority holds around 6.50. Puts have a range of 6.50-6.30 out to December 20th. We expect the market to weaken. 

USDCNY Vanilla Positioning Data 08/09/2021 - 15/09/2021

Charts and Tables

FX Expiries

Volatility Grid

Historical Spot FX Volatility (30D Rolling)

FX Matrix (today)

Weekly Change

Key Events & Releases

Technical Charts 

JP Morgan Global FX Volatility Index 

The index has strengthened in the last couple of sessions and broke above 50 MA resistance but have struggled to break above the 100 MA level. The stochastics are seen converging on the downside in the overbought, and the MACD diff is positive and converging. In order to confirm the outlook of lower prices, the index needs to reaffirm resistance at 100 MA and then take out the key support at 6.40. On the upside, a break back above 200 MA at 6.66 and a test of 6.70 would indicate further upside potential. The index fluctuated around 50 MA but has followed the downward trend for most of September, and if prices struggle to break above 100 MA, we could expect this momentum to continue.

The Dollar Index 

The index has improved so far in September and has tested resistance at 93.00, but corrected since and now stands at 92.81. The stochastics are about to converge in the overbought, and the MACD diff is positive and converging, suggesting we could see the index push lower in the near term. The index needs to hold above 50% fib level at 92.75 before targeting 93.00 once again. The reaffirmation of near term support there would suggest we could see the market push higher to 93.17. On the downside, rejection above 93.00 could trigger a break of support through the moving averages to 92.50. The 50 MA just crossed above the 100 MA, a strong buy signal, but prices need to break above 93.00 to confirm the outlook.


The pair has been mostly supported above 100 MA this week, keeping momentum on the front foot. The stochastics are edging towards the overbought, and the MACD is positive and diverging on the upside. The pair has remained supported despite the correction in the indicators mid-week, holding up above the moving averages. To confirm the outlook of lower prices, the pair needs to break below the 100 and 50 moving averages at 5.2417 and 5.2187, respectively, and then support at 5.20. On the upside, if the pair can breach 5.30 and then target 5.33, we could see a strengthening of momentum to the upside, confirming a continuation of ascending triangle. We expect prices to strengthen in the near term.



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