Last week we actually saw most Emerging Markets take a breather, resulting in most related volatilities lower across the board. There was one exception; Brazilian equity volatility.

The EWZ US (Brazil Index ETF) continued trading lower. The ETF is now approaching very big support levels. The area around 30 usd is big and marks the break out level from the summer of 2016. The trend is awful, but when assets reach this extreme pessimism one should take a deeper look, especially how investors price risk.

Next month’s elections look to be dynamic to put it mildly.

Brazilian ETF volatility (VXEWZ) has surged and continues to reach new elevated levels, despite rest of the Emerging space actually having seen somewhat lower volatilities. Volatility levels at these levels are pricing in approximately 3.4% daily moves for the Brazilian ETF.

Maybe these kind of moves will hold short term, but chasing volatility at these levels could prove expensive. Just because an asset has moved violently, doesn’t mean it will continue to move like this forever.

The spread of Brazilian versus general Emerging market volatility has reached extreme levels. Surely the elections are impacting how investors price Brazilian risk beyond the Emerging Markets exposure. The question is when will volatility become too rich?

Recent elections in Sweden saw FX vol go higher as the right wing was creating a lot of uncertainty among investors trying to price this risk. We are by no means comparing Swedish elections to what is going to happen in Brazil, but a similar type of uncertainty is taking place as the market is trying to price the elections risk.

Note how SEK/EUR 3 month atm volatility has come down post elections, despite the right wing taking a lot of the votes.

Last image shows the Brazilian ETF volatility (orange) compared to Brazilian 5 year CDS (white). Note the recent gap widening between how two related assets price elections risk.

Hedging Brazilian equity with VXEWZ is starting to look like a very late trade and could prove to be very costly insurance policy.

Source: charts by Bloomberg