Lula's Victory Triggers Sell-off of Brazilian Assets Abroad and Signals Stock Market Volatility

What happened

The victory of Luiz Inácio Lula da Silva (PT) in the presidential elections triggered a sell-off of Brazilian assets abroad on Sunday night, which intensified on Monday morning. American Depositary Receipts (ADRs) of Brazilian companies and the EWZ, the main Brazilian equity fund traded in New York, registered sharp declines. The electoral result, with 51.79% of the votes for Lula versus 48.2% for Senator Flávio Bolsonaro, defied the expectations of many analysts and banks that had bet on a change in power for the implementation of significant fiscal reforms.

Why it matters

The electoral outcome represents a setback for expectations of significant fiscal policy reforms that were being priced in by the market. The absence of a clear prospect for substantial changes in economic policy, contrary to previous bets, generates uncertainty and leads investors to reassess their positions in Brazilian assets. The surprise in the polls may lead to a period of increased volatility and asset valuation adjustments.

Market impact

• Interest rates and bonds: Future interest rates are expected to surge, reflecting increased risk perception and uncertainty about economic policy management.
• Dollar and currency: The dollar is likely to strengthen against the real, as investors flee riskier assets.
• Equities: There is a high risk of the Brazilian stock exchange (Ibovespa) triggering the 'circuit breaker' mechanism, which halts trading after significant drops. J.P. Morgan anticipates that losses will activate the mechanism, causing a 30-minute halt for every 10% drop, potentially extending to one hour if the decline reaches 15%, and suspending trading for the day if the drop hits 20%.
• Commodities: No specific information is provided in the source regarding the impact on commodities.
• Crypto: No specific information is provided in the source regarding the impact on cryptocurrencies.
• Brazil: The likely direction is strong selling pressure on local assets, with depreciation of the real, rising interest rates, and significant stock market declines. J.P. Morgan downgraded its recommendations for the real and local interest rates from 'overweight' to 'marketweight'.

What to watch

The coming days will be crucial to observe the market's reaction following the initial shock. Price stabilization and any potential recovery of losses will depend on the clarity the new government provides regarding its economic policy and investors' reactions to risk pricing. The unwinding of call option positions established after the first round may have amplified the initial losses.

Scenarios

Base scenario: High volatility and adjustment in Brazilian assets, with pressure on the real and interest rates. Downside scenario: Persistence of risk aversion and deepening losses, if there are no clear signs of moderation in economic policy.

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