Brazil ETF Tumbles in Tokyo After Lula's Runoff Victory

What happened

Luiz Inácio Lula da Silva won the Brazilian presidential election in the second round, defeating Senator Flavio Bolsonaro with approximately 52% of the votes against 48%. This result marks a notable comeback, as Lula had trailed in the first round on October 4, making him the first candidate since 1989 to lose the opening round and still go on to win the presidency. The initial market reaction came from a Tokyo-listed ETF (Exchange Traded Fund) tracking the Bovespa, which fell nearly 15% following the news of Lula's victory.

Why it matters

The decline of the ETF in Tokyo, although in a low-volume market, serves as an early signal of investors' potential reaction to Lula's victory. A sharp repricing of Brazilian assets is expected when local markets open. Goldman Sachs, for example, outlined an extreme scenario that could include a 10% appreciation of the dollar against the real, an increase of about 200 basis points in long-term government bond yields, a widening of 30 to 40 basis points in credit spreads, and a fall of approximately 15% in Brazilian equities. Although the bank framed this as an extreme case rather than a central expectation, it illustrates the scale of the repricing risk. Part of this pressure reflects investors' previous positioning, who had bet on a different outcome after the first round, when Bolsonaro led.

Market impact

• Interest rates and bonds: Long-term Brazilian government bond yields tend to rise, reflecting a perception of higher fiscal risk or political uncertainty. This could lead to increased borrowing costs for the government and companies.
• Dollar and exchange rates: The dollar tends to strengthen against the real. Political uncertainty and concerns about future economic policy may lead to capital outflow or lower investment inflows, putting downward pressure on the Brazilian currency.
• Equities: The Bovespa tends to fall, following the indication from the Tokyo ETF. Risk aversion and the potential revision of corporate earnings expectations under the new administration may negatively impact stocks.
• Brazil: A general repricing of Brazilian assets is expected, with the real, the local interest rate curve, and the Bovespa being the main focuses. The extent of the decline will depend on investors' perception of the new government's economic policies.

What to watch

Investors should closely monitor the opening of Brazilian markets to assess whether the initial reaction observed in Tokyo is confirmed or proves more contained. It will be crucial to observe the volatility of the real, movements in the interest rate curve, and the performance of the Bovespa. Furthermore, early signals and statements from Lula's team regarding economic and fiscal policy for the new term will be fundamental in determining whether the initial reaction extends or stabilizes.

Scenarios

Base scenario: Initial repricing of Brazilian assets with volatility, but with eventual stabilization as the new government signals clarity in its economic policies. Dip-buyers may emerge if the reaction is contained. Risk scenario: A disorderly and prolonged sell-off in Brazilian assets, with potential spillover to other Latin American currencies and emerging market risk sentiment, should political and fiscal uncertainty persist.

Original source: ForexLive (InvestingLive). For information only, not investment advice.