The struggle of Brazilian presidential candidate Flavio Bolsonaro to secure a running mate from an allied party signals a lack of cohesion within the opposition. This political dynamic, combined with polls favoring the incumbent, sets the stage for increased volatility in Brazilian local assets as the October election nears.

Given the unreliability of polling, markets will wait for tangible results before reacting. The composition of congress will be the first concrete signal, with a divided or right-leaning legislature seen as a positive check on executive power. This could trigger currency rallies well before the final presidential outcome is known.

For a long-term (5+ year) value investing strategy in emerging markets, hedging currency exposure is typically too expensive to be viable. The approach relies on the assumption that when buying into a country under pressure, significant currency devaluation is already priced in, making the high cost of hedging unnecessary.

Brazil's next election presents a major catalyst. An opposition win would likely unlock pent-up investment and allow high real interest rates to fall, creating a virtuous cycle. Conversely, a win for the incumbent party would likely keep rates higher for longer, suppressing growth and investment.

With the exception of Brazil's BRL, investor positioning in Latam currencies is not over-extended. This means the magnitude of currency moves should be similar in either a government continuity or transition scenario, creating a balanced risk profile rather than a one-sided vulnerability to a specific political outcome.

Unlike in 2024, the Mexican peso (MXN) is less vulnerable to a carry trade unwind sparked by Japanese yen intervention. This is due to cleaner investor positioning and fundamental supports beyond just yield. In contrast, Brazil's real (BRL) remains fragile with very long positioning and looming political risk, making it more exposed.

Despite political polarization, FX volatility is expected to be less than half of the 20% depreciation seen in the last cycle. This is due to a less tense social fabric, more moderate economic agendas, and strong institutions that have proven effective at limiting executive power and radical reforms.

Unlike local rates, the EM FX market has been less volatile amid recent geopolitical escalations. A key technical reason is that very little capital was positioned in the asset class to begin with, meaning there were fewer positions to be squeezed out, thus dampening the market's reaction.

Unlike the 2021-22 cycle which coincided with post-COVID overheating, Latam economies now boast a more resilient backdrop with lower current account deficits, positive real policy rates, and moderated inflation. This strength, coupled with appealing valuations, provides a substantial cushion against political volatility for local rates markets.