Election risks cool foreign appetite for Brazilian assets
Phoenix Kalen
Reprodução/Bloomberg TV
With just over two months to go before the presidential election, Brazilian politics is no longer a distant concern for foreign investors. In recent weeks, international banks have increasingly cited the political outlook as a key factor in pricing domestic assets.
The shift has tempered enthusiasm for long-term bets on further gains in the real, until recently a favorite among global investors, while reinforcing a more selective approach toward Brazil.
Société Générale’s recent moves illustrate the change in sentiment. Last week, the bank closed two positions betting on the real’s appreciation against the euro and the Chilean peso. It also tightened stop-loss levels on interest-rate trades to limit potential losses should futures rates rise sharply.
In explaining the changes, the bank explicitly pointed to the approaching election.
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Phoenix Kalen, Société Générale’s global head of emerging-markets research, said in a report to clients that the bank had downgraded its position on Brazil’s foreign-exchange market to neutral, as the prospect of looser fiscal policy ahead of the election and the possibility that markets were underestimating a Lula victory made the currency less attractive in the short term.
The French bank believes markets are underestimating the government’s chances of reelection.
Société Générale added that, should political risk intensify and begin to weigh more clearly on Brazilian assets, it may need to shift its view on the real to “slightly bearish.”
Election outlook
Since mid-April, when the International Monetary Fund held its spring meetings, Brazilian investors who spoke with foreign counterparts had largely concluded that the election would remain secondary in decisions involving domestic markets.
The argument was that the two candidates leading several opinion polls represented relatively familiar or manageable outcomes. President Luiz Inácio Lula da Silva of the Workers’ Party would mean “more of the same” in fiscal policy, while Senator Flávio Bolsonaro of the Liberal Party could point to a more market-friendly scenario, albeit one surrounded by considerable uncertainty over economic policy.
After a recent round of meetings with foreign investors, one strategist said Lula’s possible reelection does not alarm the group, but has dampened its enthusiasm.
“Although I believe there will be spending adjustments in the first year, most investors think very little will be done. Even so, there is no intention to leave the country or significantly reduce positions, because Brazil still offers good returns compared with the rest of the world. And while the fiscal fundamentals are poor, this is not a scorched-earth scenario.”
The strategist said foreign investors therefore remain more constructive than local investors, who have been pessimistic for some time, particularly because of disagreements over the government’s fiscal policy.
Candidate concerns
Foreign investors are “deeply discouraged” by Flávio Bolsonaro’s candidacy, the strategist said.
That reflects “not only the weakness he has shown during the campaign, but also the absence of any concrete post-election plan and concerns about an institutional crisis and parallel political disputes that could drain the government’s energy.”
Interest in a third-way candidate is also limited, although some investors have shown curiosity about Renan Santos, the presidential hopeful from the Mission Party, the strategist added.
Jefferies analysts Inigo Vega and Diego Sarmento Pereira, who recently visited Brazil, also highlighted the lack of market enthusiasm, particularly after the government introduced a series of fiscal and credit measures.
One of the main conclusions from their trip was “the government’s growing reliance on unconventional measures amid an economic slowdown, expectations that real interest rates will remain high for longer and the approaching election.”
Vega and Pereira said the Lula administration appears less focused on challenging monetary policy and more concerned with adopting offsetting measures to support the economy and credit.
“Although none of the measures is, in itself, negative for banks’ credit quality, investors tend to question not only the sustainability of these support mechanisms, but also whether they could increase the chances of the electoral outcome that markets apparently view as least desirable,” they said.
Real outlook
Wells Fargo strategist, Alvaro Vivanco, has also dropped his favorable view of Brazil’s currency, arguing that investors should step aside after the real’s positive trade reversed during the war in Iran.
Vivanco said uncertainty surrounding the election and fiscal policy has also increased, “including the significant improvement in President Lula’s support in opinion polls.”
Together, these factors “have been particularly damaging to the real, as long positioning in the currency was quite stretched, reflecting a trade that had become a broad market consensus, even when the dollar fell below R$5.”
Vivanco believes the real may become attractive again when— and if—the dollar approaches R$5.30, but he sees no urgency to resume buying the Brazilian currency before then.
“We expect the dollar to rise against the real. We need greater clarity on commodity prices, U.S. interest rates and domestic politics,” Vivanco said.
Market caution
Barclays strategist, Andrea Kiguel, is also maintaining a cautious stance on Brazilian markets because of the political uncertainty.
“Historically, presidents seeking reelection tend to experience a significant improvement in their net approval ratings in the months leading up to the vote, and we believe market volatility is likely to increase as this process unfolds,” Kiguel said.
Even under a change of government, she said, “the legacy left to the next administration is likely to be difficult, requiring the implementation of ambitious structural reforms.”
Kiguel believes the interest-rate market could benefit from a more favorable political outcome. Still, she sees limited scope for the equilibrium interest rate to fall sharply and quickly, potentially restricting positions that bet on lower rates.
In the foreign-exchange market, she expects the real to underperform other currencies “as the October presidential election approaches, since local investors and companies typically increase dollar purchases when races are close and the potential economic outcomes are perceived as binary, as we expect in October.”
