Wall Street is intently watching Brazil’s upcoming presidential election, anticipating dramatically different market outcomes depending on whether Lula da Silva or Flavio Bolsonaro wins. Investors largely favor Bolsonaro, expecting a rally in Brazilian bonds, currency, and stocks due to his promise of fiscal discipline and potential for robust reforms.
Conversely, a Lula victory is projected to lead to a different market trajectory. The high stakes election, coupled with legislative races, will determine the country’s economic policy direction and its impact on global markets.
As Brazil's pivotal presidential election enters its first round this Sunday, Wall Street analysts are meticulously preparing for starkly divergent market reactions based on whether leftist Luiz Inacio Lula da Silva or right-winger Flavio Bolsonaro emerges victorious. The race is exceptionally close, prompting a crucial question for global investors: "The Brazil trade is: Does Lula win or does Bolsonaro win?" as Fernando Marengo, chief economist at Black Toro Global Investments, articulately puts it.
These names, Lula, an 80-year-old veteran running for his fourth term, and Flavio Bolsonaro, 45, son of former President Jair Bolsonaro, are at the heart of the market's uncertainty. Should neither candidate secure over 50% of the vote, a runoff election is scheduled for October 25.
Market consensus largely favors Bolsonaro, predicting a rally across Brazil's bonds, currency, and stocks if he wins. This sentiment is reinforced by recent trends: as Bolsonaro's poll numbers have improved, Brazilian stocks have mirrored this upward trajectory. JPMorgan, in a recent client note, highlighted that the MSCI Brazil index "rose by 0.25% on average each day that Flavio gained in the polls."
Despite some prediction markets like Kalshi showing Bolsonaro with a 60% chance against Lula's 39% (though such markets are prohibited in Brazil and may not fully capture local sentiment), experts like Richard Lapper of Aurora Macro Strategies caution that the shift towards Flavio isn't as pronounced as these platforms suggest.
Bolsonaro's appeal to the markets stems from his platform promising greater fiscal discipline – a critical need for Brazil, which faces a debt-to-GDP ratio of 81.9%, a 10% increase since Lula's last tenure. Leonardo Porto, Brazil head economist for Citi, underscores the necessity for a "3-3.5% fiscal adjustment to stabilize the public debt in relation to GDP," emphasizing that this must involve permanent measures beyond one-off privatizations. With Brazil's budget largely mandatory and its tax burden already the highest in Latin America at 32% (according to the OECD), achieving these adjustments will be challenging.
However, the upside potential with a Bolsonaro win and a "robust reform agenda" is significant, according to JPMorgan. They point to the prior administration of Jair Bolsonaro (Flavio's father), which successfully implemented pension reform, saving hundreds of billions of dollars by raising the minimum retirement ages. During that reform period (2016-2020), Brazil's 2-year yields plummeted to nearly 4.7%, and the equity market soared by 130%.
If Brazil embarks on another reform cycle, JPMorgan analysts project interest rates could fall to their neutral level (6% real, 10% nominal), potentially boosting the MSCI Brazil by 21% to 41%. The forward Price-to-Earnings (P/E) ratio could climb from its current 8.6 to as high as 13.3, a level last seen in 2020. The currency market is also set for a "bimodal" outcome, with JPMorgan forecasting USD/BRL at 5.50 if Lula wins and 4.90 under a Bolsonaro victory.
The composition of the legislature, with the entire lower house and a third of the upper house also being decided, will be crucial for any reform efforts. Fernando Marengo of Black Toro notes that similar pro-business victories in other Latin American nations, like Colombia and Peru, have led to significant gains in stocks, bonds, and currencies, though he cautions that some of this optimism may already be priced into the Brazilian market.
Beyond domestic politics, emerging markets, particularly Latin America, face ongoing risks from rising global interest rates and potential crop damage from the El Niño weather phenomenon.
Disclosure: CNBC and Kalshi have a commercial relationship that includes customer acquisition and a minority investment.
