25 September 2015 FX Forecasts and Valuations: Don't throw in the towel Lett Amines Brazil After months of negative signals but overall relative stability, the policy backdrop in Brazil appears to be quickly unraveling, and the BRL is following suit. USD/BRL is now about 70% higher on the year (BRL REER 20% weaker), and more is likely in store given the potential for further political and policy deterioration (as well as the intensifying recession and unfavorable external backdrop). A policy u-turn could include a return to stronger intervention in the currency - for now, the BCB continues to roll expiring FX swaps at 100% and it has also begun increasing its dollar repo offering. Given the strong headwinds faced by the BRL, however, we don't believe that stronger intervention should have a material impact. We therefore take a bearish stance on BRL, notably versus MXN within Latam, and expect USD/BRL dips below 4 to be bought. Maxlco USD/MXN is now 23% higher than it was in July 2014 and on a real trade-weighted basis, MXN is at a nearly 20-year low. This is comparable to other EM currencies that have suffered a much larger terms of trade shock from commodities or that have high CA deficits / high local risks (see chart at the beginning of this publication). Valuations, still-stretched positioning, Banxico vigilance regarding the currency, and, Banxico matching Fed hikes at the beginning of the cycle, all support being long MXN versus other Latams, despite the continued downward revision of growth forecasts. We prefer to be long vs. EM peers as USD/MXN could continue higher on negative EMFX sentiment (frequently expressed through USD/MXN) and general dollar strength. We enter long MXNWEIRL, despite already high levels, and suggest financing 3m USD/MXN puts ATMS by selling 3m USD/COP puts The already battered COP was hit hard by the risk-off sentiment and renewed oil weakness. While the adjustment in the currency has been impressive (more than 2