Foreign outflows and election outlook pressure Brazilian market
Emy Shayo Cherman, with J.P. Morgan, helped draft the report
Mauricio França/Divulgação
Investor sentiment toward domestic markets soured during Tuesday’s (11) session, triggering steep losses across Brazilian assets. The stock market posted the worst performance. The Ibovespa fell more than 2% and dropped below the 170,000-point mark, in a move amplified by J.P. Morgan’s downgrade of Brazilian equities. Foreign investors’ exit from the stock market, which had already accelerated significantly since last week, intensified and also affected the currency and interest-rate markets, which came under pressure from higher risk premiums as the presidential election began to have a clearer impact on trading.
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Concerns over the election outlook intensified after the release of a CNT/MDA poll showing a wide lead for President Luiz Inácio Lula da Silva (Workers’ Party, PT) over Senator Flávio Bolsonaro (Liberal Party, PL, Rio de Janeiro) in voting intentions—13.7 percentage points in the first round and nearly 9 percentage points in a potential runoff between the candidates.
With market participants eager for a change in economic policy management starting in 2027, the poll added to pressure on domestic assets, which had already come under strain after J.P. Morgan downgraded its recommendation on the local stock market from “overweight” to neutral.
According to the U.S. bank, following a positive July, the balance of risks for Brazil is expected to become less favorable for the rest of 2026. From a global perspective, J.P. Morgan expects U.S. interest rates to rise, which should strengthen the dollar. Domestically, the Selic is expected to fall only to 13.75%, according to the bank’s forecast, which would not provide meaningful support for local stocks. In addition, the election period is expected to bring greater volatility and put pressure on Brazilian assets.
“Brazil is likely to underperform, both in absolute and relative terms, in the six months leading up to the election. Following the recovery seen in July, when the MSCI Brazil Index rose 6.3%, outperforming both the MSCI Latin America and MSCI Emerging Markets indexes, we believe it is time to adopt a more conservative stance,” J.P. Morgan’s report says. It adds: “Both equities and the real have traded within a range since May, indicating that there is little election premium or discount priced in.”
The bank’s warning ultimately triggered a broad withdrawal of foreign investors’ allocations to Brazil, sending the Ibovespa down 2.50% to 167,875 points and marking its biggest daily decline since March.
Christian Keleti, with AlphaKey
Rogerio Vieira/Valor
“The market is becoming dysfunctional because many stocks are trading below four times price-to-earnings. And no significant buyer is coming in,” said Christian Keleti, CEO and portfolio manager at AlphaKey. He also considers J.P. Morgan’s downgrade of Brazil’s recommendation because of the election outlook to have come too late, since there have been no significant changes in recent months while domestic stocks have undergone a sharp correction.
“Lula has never stopped being ahead. Three months ago, the scenario was the same and stocks were between 20% and 50% above current levels. So, if the assessment was to sell because of political uncertainty, the downgrade should have been made in April or May. In August, it is coming late,” he said.
In the foreign-exchange market, the dollar rose 0.98% to R$5.1606, while futures interest rates increased across the forward curve, with the January 2029 DI contract rate rising from 14.09% to 14.18% a year.
Thierry Larose, a portfolio manager at Swiss asset manager Vontobel Asset Management, said uncertainty surrounding the post-election outcome is increasing as investors become more concerned that none of the candidates appears willing to carry out the deep fiscal adjustment Brazil needs. “Although I believe this adjustment is ultimately inevitable, the risk is that any measures adopted may appear too modest to restore confidence,” he said.
For now, the prevailing view at the firm is that domestic interest rates are pricing in more risk than the currency market. “With economic growth slowing and inflation expectations beginning to stabilize, the Central Bank has ample room to continue its monetary easing cycle, barring a sharp depreciation of the real.”
“In our view, interest rates offer a more favorable asymmetry, with substantially greater room for a rally in a positive scenario than for a decline in a negative scenario,” he added.
Thierry Larose, of Vontobel Asset
Rogerio Vieira/Valor
On the market’s pricing of who will win the election, Larose said markets are clearly positioned for a Lula victory, as prediction-market platforms also indicate. “But domestic interest rates are the only asset class that is pricing in this outcome to a significant degree.”
Given the low allocation to higher-risk assets by local investment funds following a prolonged period of investor redemptions, foreign capital flows are most likely to continue amplifying volatility and determine the direction of domestic markets over the coming months, according to Igor Barenboim, chief economist at Reach Capital.
“‘Real money’ [the investor with long-term allocation capacity] will not change; what will change are portfolio flows. Foreign investment funds should hedge against election volatility, give up Brazil’s high interest-rate carry and return after the election, depending on what fiscal plan is delivered,” Barenboim said.
If the scale of this foreign capital outflow is large enough to stabilize the dollar at higher levels, at R$5.25 or above, it will be difficult for the Central Bank to make even the final 0.25-percentage-point Selic cut currently priced into the forward curve, the economist said. On the other hand, if the outlook remains benign, both in terms of the exchange rate and economic activity and inflation data, the Copom could go further and cut the Selic to 13.5%.
But regardless of the short-term outlook, Barenboim sees little asymmetry to exploit in interest-rate strategies. “I can’t see more than one or two more cuts now; it would be difficult to justify. Next year, if a good fiscal plan is announced, cuts may continue,” he concluded.
Igor Barenboim, with Reach
Rogerio Vieira/Valor
