Spot Dollar Sees Largest Weekly Gain Since 2008 Global Crisis on Lula's Re-election

What happened

The spot dollar ended the week with a significant appreciation against the Brazilian real, marking the largest weekly gain since the 2008 global financial crisis. The US currency accumulated a 9.04% appreciation over the week, driven by the repricing of Brazilian assets following the re-election of President Luiz Inácio Lula da Silva (PT).

On Friday (October 30th), the dollar advanced 1.05%, closing at R$5.4442. Throughout the day, the exchange rate fluctuated between R$5.3872 and R$5.4621. For the month of October, the dollar registered a 5.22% increase. The commercial euro also followed the upward trend, appreciating 1.12% to R$6.0803.

The Brazilian real showed one of the worst performances of the day among global currencies, surpassed only by the Israeli shekel and the Colombian peso. In international markets, the DXY index, which measures the dollar's strength against a basket of six developed currencies, was down 0.14% by late Friday afternoon.

Why it matters

The sharp appreciation of the dollar reflects the frustration of a significant portion of the financial market with the electoral outcome. There was a substantial bet on Senator Flávio Bolsonaro's victory, and his defeat triggered an abrupt adjustment in Brazilian asset prices. Uncertainty surrounding the economic and fiscal policy management of the new Lula administration also contributes to increased risk aversion and a search for assets considered safer.

Hedgepoint, in an analysis, classified the dollar's upward movement as tactical, indicating no structural change in the medium term. The firm notes that the "wide carry" (interest rate differential) continues to support the real, but points out that fiscal issues, risk aversion, and the pricing of US interest rate hikes (Fed) weigh in favor of the dollar. Counterbalances such as falling oil prices and a weaker DXY were, for now, ignored by the market.

Market impact

• Interest rates and bonds: Currency volatility and fiscal uncertainty tend to push Brazilian government bond yields higher, reflecting a greater risk premium demanded by investors. Fixed-income securities tied to the Selic rate may benefit in the short term, but the prospect of higher inflation and prolonged high interest rates could affect pre-fixed and inflation-linked fixed income.
• Dollar and exchange rate: The upward trend for the dollar is likely to persist in the short term as long as fiscal and political uncertainties are not dispelled. The real's volatility is expected to increase, and the currency may test higher levels.
• Equities: The Brazilian stock market (Ibovespa) is likely to suffer from capital flight and risk aversion, particularly affecting stocks of companies more sensitive to the domestic scenario and the exchange rate.
• Commodities: The impact could be mixed. Commodities priced in dollars may see their prices in reais rise, but global demand and the strength of the US dollar in the international arena also play a role.
• Brazil: The likely direction for Brazilian assets is caution and volatility. Pressure on the real and the stock market is expected to continue while the market awaits clear signals regarding the fiscal policy and the economic team of the new government.

What to watch

Investors will be closely monitoring upcoming signals regarding the Lula administration's fiscal policy, including the selection of names for the Ministry of Finance and the presentation of budget proposals. The minutes of the Copom meeting, to be released next week, and the US midterm elections (November 3rd) will also be important for market direction.

Scenarios

Base case: The dollar maintains high volatility, with the market awaiting clear fiscal signals. The real may show some recovery if signs of fiscal responsibility emerge, but uncertainty is likely to prevail.

Risk case: The absence of clear fiscal signals or the adoption of policies considered expansionary could lead to a further depreciation of the real and upward pressure on interest rates and inflation.

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