Brazil's Future Interest Rates Plummet After Flávio Bolsonaro Leads First Round

What happened

The Brazilian fixed income market saw a broad and significant rally on Monday, with future interest rates and yields on inflation-linked government bonds (NTN-Bs) registering substantial declines. This movement occurred after Senator Flávio Bolsonaro (PL-RJ) unexpectedly surpassed President Luiz Inácio Lula da Silva (PT) in the first round of the presidential election, a result that caught markets by surprise.

The declines were notable: long-term future interest rates fell by more than 1 percentage point. For instance, the DI contract rate maturing in January 2031 plummeted from 13.99% to 12.655%, reaching its lowest level since October 24, 2024. NTN-B rates also dropped, with many points on the real interest rate curve trading below 7%. The NTN-B rate for August 2050 receded from 7.15% to 6.72%. The intensity of the movement was such that B3 had to twice expand the daily fluctuation limit for DI contracts, an event not seen since March 2020.

Why it matters

Flávio Bolsonaro's lead in the first round, coupled with a significant 'right-wing wave' in the National Congress, particularly in the Senate where the PL party secured the largest bloc since 1988, was interpreted by the market as a signal of a higher probability of adopting economic policies considered more orthodox and pro-market. The expectation is that a right-wing government would be more inclined to implement spending cuts and fiscal reforms, which tends to reduce the risk premium embedded in Brazilian assets and, consequently, interest rates.

Market analysts indicate that the strong reaction is due to many investors being positioned for a tie or Lula leading, rather than Bolsonaro's advantage. Current market pricing suggests a high probability of Flávio Bolsonaro's victory in the second round, which fueled the fixed income rally.

Market impact

• Interest rates and bonds: The impact was direct and significant. Future interest rates and government bond yields (fixed-rate and inflation-linked) plummeted. This means that the cost of borrowing for the government and companies tends to decrease, and previously issued fixed income securities with higher rates appreciate. The movement was one of the most intense in domestic fixed income in recent years.
• Dollar and exchange rate: The perception of a more market-friendly political scenario tends to attract foreign capital, which could lead to an appreciation of the real against the dollar. Although the news does not detail the exchange rate movement, falling future interest rates and a fixed income rally typically accompany local currency appreciation.
• Equities: The reduction in country risk and the expectation of more liberal economic policies tend to be positive for the stock market. Companies may benefit from a lower interest rate environment and increased investor confidence, which could boost the Ibovespa.
• Brazil: The shift in political and economic risk perception in Brazil is the main driver of these movements. The expectation of a government with greater right-wing alignment and a more conservative Congress signals a potential agenda of reforms and fiscal adjustment, which is viewed positively for macroeconomic stability and investment attraction.

What to watch

Investors will be closely monitoring developments in the second-round campaign, seeking more details on the candidates' economic plans, especially regarding spending cuts and reforms. Statements and proposals signaling greater fiscal responsibility or, conversely, increased spending, could influence market direction. The formation of political alliances and the tone of debates will also be crucial for risk pricing.

Scenarios

Base Scenario: The perception that Flávio Bolsonaro has a high probability of winning the second round continues to support the fixed income rally, with interest rates and bond yields remaining at lower levels as the market seeks details on the economic agenda. Risk Scenario: Should there be a significant shift in polls or second-round expectations, indicating a lower probability of Flávio Bolsonaro's victory or an economic agenda less aligned with the market, future interest rates could reverse some of the recent declines.

Original source: Valor Econômico. For information only, not investment advice.