As Brazil’s presidential election nears its first round, global markets are bracing for dramatically different outcomes depending on whether leftist Luiz Inacio Lula da Silva or right-winger Flavio Bolsonaro secures victory. Financial experts anticipate a rally in Brazilian assets if Bolsonaro wins, driven by promises of fiscal discipline, while a Lula win could trigger different market responses. The race remains tight, with a potential runoff on October 25th if neither candidate achieves over 50% of the vote.
With Brazil's pivotal presidential election heading into its first round this Sunday, financial titans on Wall Street are meticulously strategizing for two profoundly different market scenarios, contingent on the race's outcome. "The Brazil trade is: Does Lula win or does Bolsonaro win?" queried Fernando Marengo, chief economist at Black Toro Global Investments, encapsulating the market's focal point.
The familiar names refer to 80-year-old leftist Luiz Inacio Lula da Silva, vying for a fourth term, against 45-year-old right-winger Flavio Bolsonaro, son of former President Jair Bolsonaro. Should neither candidate achieve more than 50% of the vote, a runoff election is slated for October 25.
A victory for Bolsonaro is widely anticipated by Wall Street to catalyze a rally across the country's bonds, currency, and stocks. Notably, as Bolsonaro gained ground in recent months, Brazilian equities mirrored his upward trajectory in the polls. JPMorgan highlighted this trend, noting that the MSCI Brazil index "rose by 0.25% on average each day that Flavio gained in the polls."
While Kalshi markets currently show Bolsonaro with a 60% favorability compared to Lula's 39%, it's crucial to remember that prediction markets are prohibited in Brazil, potentially skewing their reflection of local sentiment. Richard Lapper, senior advisor at Aurora Macro Strategies, observed that "the balance has shifted toward Flavio over the past month, but not nearly as far as the prediction markets are pricing."
Bolsonaro is generally the preferred candidate among market participants due to his commitment to increased fiscal discipline, an imperative many economists believe Brazil desperately needs. The nation's debt-to-GDP ratio currently stands at 81.9%, a significant 10% increase since Lula last held office.
"We need a 3-3.5% fiscal adjustment to stabilize the public debt in relation to GDP," explained Leonardo Porto, Brazil head economist for Citi. He emphasized that this adjustment cannot rely solely on one-off measures like state asset privatizations, but rather requires a "permanent fiscal adjustment." This implies difficult choices between spending cuts or tax hikes, with roughly 90% of Brazil's budget being mandatory, much of it constitutionally mandated. Furthermore, Brazil's tax burden, at 32%, is already the highest in Latin America, according to the OECD, and its economic growth prospects remain low.
Nevertheless, substantial gains are foreseen if Bolsonaro wins and successfully implements a "robust reform agenda," as JPMorgan suggests. The firm points to the period under his father, Jair Bolsonaro, from 2016 to 2020, during which significant pension reform was passed. This reform, which imposed minimum retirement ages of 65 for men and 60 for women (up from average ages of 56 and 53 respectively), yielded hundreds of billions of dollars in savings.
During that reform period, JPMorgan noted a remarkable decline in Brazil's 2-year yields to almost 4.7%, alongside a staggering 130% gain in the equity market. Should Brazil embark on another era of reform, JPMorgan analysts project that interest rates could fall to their neutral level (6% in real terms, 10% in nominal terms), potentially leading to a "MSCI Brazil upside potential between 21% and 41%." They anticipate the forward P/E could surge from its current 8.6 to as high as 13.3, a level last observed in 2020.
The currency outlook is described as "bimodal" by JPMorgan, forecasting USD/BRL to move to 5.50 if Lula wins, and to 4.90 if Bolsonaro is victorious. The election also determines the entire lower house and one-third of the upper house, with the legislative composition being a critical determinant for the feasibility of reforms.
Black Toro's Marengo highlights that recent successes of pro-business candidates in other Latin American nations have typically led to significant rallies in their respective stocks, bonds, and currencies. He cited Colombia's risk premium compression of "about 200 points" and its stock market becoming "one of the most risen" as examples, similar to Peru's experience. However, Marengo cautions that some of this positive market sentiment might already be factored into Brazil's current pricing.
As with all emerging markets, a primary risk remains rising global interest rates. For Latin America specifically, the El Niño weather phenomenon poses a threat, potentially causing crop damage for agricultural exporters.
