Futures Rates Soar After Lula's Reelection, Prompting Treasury Interventions

What happened

Brazilian futures rates surged by over 15% in Monday's session, October 26, with the exception of the short-term maturities of the yield curve. This movement occurred in response to the surprising reelection of President Luiz Inácio Lula da Silva (PT) for his fourth term, after he overturned a first-round deficit. Lula's victory, which was not the base scenario for many investors, triggered an intense liquidation of positions and dysfunction in the fixed income market. B3 had to raise daily fluctuation limits three times, and the National Treasury intervened twice in the public bond market to try to contain volatility. DI rates maturing in January 2027 rose from 13.465% to 13.725%; those for January 2028 jumped from 12.855% to 14.905%; those for January 2029 soared from 12.64% to 15.25%; and those for January 2031 recorded a robust increase from 12.64% to 15.24%. In the NTN-B market, stress was also significant. Long-term rates, which previously fluctuated below 7%, rose by more than 1 percentage point, returning to levels above that mark, while short and medium-term real interest rates surged by more than 1 percentage point, returning to the 8% range. Long-term rates even surpassed 16%, reaching their highest intraday levels since 2015.

Why it matters

The market reaction reflects investors' positioning for a different election outcome and the perception of an increased fiscal risk premium in Brazil. According to Luis Felipe Vital, head of macro strategy and public debt at Warren Investimentos, the market had priced in a scenario of an opposition victory, and with Lula's reelection, it had to reverse this positioning and add risk premiums due to an already challenging fiscal framework, which was perceived as even more fragile after government measures announced late in the campaign. The dysfunction observed in the fixed income market, with interventions by the Treasury and B3, signals the intensity of the shock and the need to readjust expectations about future economic policy. Uncertainty about the direction of fiscal adjustment and the autonomy of the economic team are critical points for risk perception.

Market impact

• Interest rates and bonds: Brazilian futures rates and public bond yields soared, with long-term rates reaching their highest intraday levels since 2015. This reflects a significant increase in the risk premium demanded by investors to finance Brazilian public debt, given fiscal uncertainty. The trend is for continued upward pressure until there is clarity on the new government's economic agenda.
• Dollar and exchange rates: Although the news does not detail the dollar's movement, stress in futures rates and risk aversion tend to push the real down against the dollar, as investors seek safer assets or higher returns in other economies.
• Equities: The Brazilian stock market (Ibovespa) tends to react negatively to a generalized increase in risk premium and higher interest rates, which raise the cost of capital for companies and reduce the present value of future earnings. More indebted sectors or those dependent on credit may be particularly affected.
• Brazil: The country faces a higher cost of borrowing for the government and companies, which can impact investment and economic growth. The perception of elevated fiscal risk can hinder the attraction of foreign capital and put pressure on inflation, should expectations become unanchored.

What to watch

Investors will be closely monitoring any signals from President Lula regarding the composition of his economic team, especially the future Minister of Finance, and a possible commitment to fiscal adjustment. Statements and actions indicating a more pragmatic and fiscally responsible stance could help calm markets. Tracking the evolution of public bond yields and the National Treasury's actions will be crucial to assess market stabilization.

Scenarios

Base scenario: The Lula government signals a commitment to fiscal adjustment and presents names for the economic team that inspire confidence. Part of the current risk premium is consumed, and futures rates tend to gradually decline, although remaining at elevated levels. Risk scenario: The absence of clear signals of fiscal adjustment or the indication of an economic team perceived as less committed to fiscal responsibility could perpetuate market stress, keeping futures rates at high levels or even raising them further, with negative impacts on the economy.

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