03.06.201606:03:00UTC+00Fxwirepro: Brazilian Fiscal Growth Surprises But Seems Dubious to Improve ahead - Hedge Usd/brl Risks by Shorting Strangle

The Q1 GDP and April fiscal releases this week managed to surprise us to the upside. As such, we see some upside risk to growth and fiscal forecasts.

The Brazilian economy shrank 0.3% in Q1 of 2016, following a downwardly revised 1.3% contraction in the previous period and beating market expectations of 0.8% decline.

The smallest drop since the first quarter of 2015, aided by rising exports and a rebound in government expenditure.

 Nevertheless, the domestic economy remains in very bad shape, and given that increased government spending was a key factor behind the better-than-expected Q1 GDP number, we remain sceptical about Brazil’s fiscal prospects.

On the other hand, the government’s urgent focus on restoring fiscal balances could represent a downside risk to growth prospects.

Moreover, domestic demand is still falling sharply and is unlikely to bottom any time soon.

Therefore, the economy will likely remain in recession this year, thereby adding to the existing fiscal challenges.

While, the Brazilian inflation figures for the first fortnight of March has printed at 0.43%, where food and administered prices have continued to lose steam taking the IPCA-15 down in the first half of March.

Consumer prices in Brazil increased by 10.36% year-on-year in February of 2016 slowing from a 12-year high growth of 10.71% in January, while staying below market consensus. 

We forecast USDBRL to clear 3.75 phase by end of Q3 and to oscillate between 4.3 and 4.4 range in Q4.

As a result, one can stay long in far month futures for hedging upside risks ahead of Fed's monetary policy decisions as the bulls may resume at any time and spikes are expected, but any abrupt slumps should not be panicked, or alternatively one can also think of initiating longs in USD/BRL 1Y ATM calls vs sell 18M strangle, 1:2 vega.