Macro Funds’ FX Bets Amplify Year of Losses After Lula’s Shock Re‑Election

For macro hedge‑fund traders, the threat of job cuts has loomed all year.

Short‑rates volatility strategies have imploded on several occasions: at the start of the Iran war in March, after comments from Fed chair Kevin Warsh in August, and following an unexpectedly hawkish rate outlook from the European Central Bank in September.

Many traders have been told to move on after the latest blow‑out. Some estimates put the number of portfolio managers dismissed in recent weeks at more than 70, possibly over a hundred.

Soured foreign‑exchange bets now compound the distress.

The second round of Brazil’s presidential election was widely expected to be an easy win for Flavio Bolsonaro, with Polymarket giving him a 75 % chance of victory. Traders viewed this as positive for the Brazilian real.

Looking ahead, the macro calendar could further unsettle markets

FX options dealers estimate that roughly 95 % of trades were positioned for a stronger real, using limited‑loss structures such as put spreads, digital options and risk reversals.

Lula’s shock re‑election sent the USD/BRL spot soaring 12 % – from about 4.95 to nearly 5.60 when Brazilian markets opened on Monday, Oct. 26.

Even hedge funds that had employed call spreads – e.g., buying a 5.20‑strike call and selling a 5.25‑strike call – saw the spot price breach those levels.

One trader at a large US bank compared the move to the 2016 Trump election, when the Mexican peso fell 12 % overnight and trading spiked to 63× normal volume.

In USD/BRL, dealers report that at the opening most activity was stop‑outs and unwinds from hedge funds that bet on the wrong candidate, prompting short‑term position adjustments for a higher USD/BRL.

CME Group’s Brazilian real futures hit a new daily volume record of 500,000 contracts, with a notional value of $9.20 bn – about two‑and‑a‑half times the previous record set on Sep. 28. CME says $2.5 bn was traded before Brazilian markets opened at 9:20 am ET.

According to the Depository Trust & Clearing Corporation’s Swaps Data Repository, over $8.5 bn in vanilla USD/BRL FX options traded on Oct. 26, with an additional $13 bn the following day.

Some believe the market absorbed the shock well. However, if dealers were short USD/BRL or short gamma (i.e., over‑hedged with sold options), the spot gap at market open would have proved painful.

Further shocks

Looking ahead, the macro calendar could further unsettle markets. The Bank of Japan will release its outlook report on Oct. 30, while the U.S. mid‑term elections are imminent and the final Federal Open Market Committee meeting on Dec. 8 could set the tone for rate‑setting policy into 2027.

Barclays researchers said this week that FX volatility will likely increase because of dollar appreciation, heightened interest‑rate volatility and cross‑country dispersion.

A higher FX volatility regime may spell trouble for the carry trade – a strategy that, while most other approaches have failed, has been a mainstay for macro funds.

Carry trades involve borrowing in lower‑interest‑rate currencies to buy those offering higher rates, assuming that spot movements during the trade will not erase the investment gains. These strategies are popular during low‑volatility periods.

Barclays notes that carry‑to‑volatility ratios have fallen since late August for currencies such as the Brazilian real, Colombian peso and Mexican peso, meaning lower payoff for the risk taken.

The Bloomberg FX emerging‑market carry index, which tracks cumulative returns of carry positions in eight emerging‑market currencies funded by shorting the U.S. dollar, fell from 300.2 in early September to 289.6 on Oct. 29. Over the same period, the U.S. dollar index rose from 98.6 to 102.8. Further dollar strength could cause a painful unwind of these carry trades.

“In the current environment, we do not see value in chasing global carry trades, as EM FX spot values are likely to reprice,” the Barclays researchers state.

For traders, the question many will ask is: “Can it get any worse?” With that potential tap on the shoulder looming, the options for safe and reliable performance seem only to be narrowing.

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