Wednesday, July 27, 2011

Why the BRL is starting to worry me (more) Part I

Today our beloved minister Guido Mantega came out to announce a tax on excessive short USDBRL positions.
Not a single soul I talked to understood the measure, even after the interview which was broadcast on TV.

My understanding was basically that, any speculative short positions on the USDBRL would be taxed 1% of the notional.
Meaning: you're an exporter of commodities, for example, and have planned inflows of 40m USD within 3 months. You can then sell 40m USDs in the future for X BRLs. If you sell 41m USD you will pay 1% over 1m USD (41m short x 40m long in receivables).

Now, if you are a hedge fund based in Croatia... and you have a positive view on Brazil (or just hate the USD like I do), long or short term, you can, yes, short the USDBRL (buying the BRL) in the onshore markets, BUT... you will be taxed 1% when you put the position on. If you decide to take a break for a few days to watch the Debt Ceiling debacle for example, to then get your short USDBRL back... You're paying another 1%.

Yes, the carry here is massive. The current yield on floating-rate sovereign bonds is 12.42%/year (98bp/month). The yield on USDBRL NDFs or futures goes down a bit, to around 9.00%/9.50%/year. Still great, right?

But you have, now, no mobility. You can't get in and out of positions in this cross. You have to sit tight and watch the carry help you out and hope the direction of the cross will remain intact. Or, to cope with possible pain, have a much smaller position (as I have here for other reasons).
Now let's say you want to do AUDBRL. Again.. if you do USDBRL x AUDUSD.. (as most people do) you will have to pay the 1% on the USDBRL position. This time the carry is much smaller since base rates in Australia are north of 4.50%.

I believe my understanding might not be correct since the USDBRL market today corrected dramatically from the opening highs. I think a lot of players are skeptical about the government's measure. At the end of the trading day the cross took a beating. Mantega has no credibility and these measures, as I took them, are drastic.

My understanding simply screams "Who the hell will be the sellers of USDBRL?"

The exporters only on a net-net position.

Because speculators will be severely penalized for doing it onshore and if they try to do it offshore their market makers will end-up on the other side of the trade on the onshore market. The BRL isn't convertible. It can only be settled within Brazil.

And I think that if I am right this cross will go up for some time, perhaps like the USDTRY (discounting for the yield gap and some of the fundamentals). Or implied volatility in options will become much, much more expensive.

Liquidity should dry up. Am I right? I think so. Look at BM&F Bovespa's stock price today. The local index dipped 2%, but this single stock dropped 5.5%. It seems people who own this company, the local derivatives and stock exchange, believe volumes will decrease or that at least, compared to the almighty local risk-free rate, the CDI @ 12.40%/year, its fwd P/E of 12.7 is still high (yield of 7.80%!!!).

Now I had 2 positions that include the BRL.
One of them was the (Short IBOV Index 1.0x + Short USDBRL 1.4x) and the other is the currency basket.

I chose to reduce this position last week (here) and today, watching Mantega 'The Crazy' on TV, I decided to get out of the remaining position as mentioned here.

I will stick with BRL in the basket, though. Reasoning in a future post.

*Disclaimer: charts and data are presented as I receive/see them. Sources are usually not checked for validation and my own calculations are of 'back of the envelope'-type. I am aware that some math that I do myself might be wrong and/or misleading to some extent. In financial markets the rate of change of economic data is often more important than the actual level and the perception of 'what is priced in' is more important than 'what is actually going to happen'. This is actually the way people pick entry and exit points. So... yes, sometimes you might say 'This guy is an idiot, this is way wrong!' with a high conviction, being right. Not to worry. Markets are made of expectations and the clash of conviction between its participants. Portfolio managers know that being an idiot is sometimes profitable and being smart is often a bad choice. It is all reality, sometimes good, sometimes bad. By the way: corrections to my analysis and intelligent debate is welcome. theintriguedtrader AT gmail do com

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