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EM FX hedging effectiveness with high inflation differentials
I've been looking at some LatAm exposures, specifically how corporate treasuries might manage $BRL or $MXN exposure when local inflation runs significantly higher than the hedger's base currency. Standard forward points account for interest rate differentials, which often align with inflation differentials, but sometimes the spread is quite volatile, or there's a significant risk premium baked in. Are institutions generally just accepting the forward costs and hoping for trade benefits, or are there more dynamic strategies for hedging the real value of these FX exposures, especially given the costs involved?
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That's a very pertinent observation. The effectiveness of standard forward hedging can indeed be skewed when inflation differentials diverge significantly from interest rate differentials, or when local central bank interventions distort the short-term rate environment. Have you looked into the carry implications if the inflation differential persists?