Investors are betting that Flávio Bolsonaro, backed by a much more conservative Congress, can defuse Brazil's loudly ticking debt bomb and unleash a perenially cheap stock market.
"A deeper and durable fiscal adjustment has become our base case," says Alejo Czerwonko, chief investment officer for emerging markets at UBS Global Wealth Management.
The iShares MSCI Brazil exchange-traded fund jumped 12% after Flávio -- who goes by his first name to distinguish himself from his father, currently imprisoned ex-president Jair Bolsonaro -- romped to all but assured victory over incumbent Luiz Inácio Lula da Silva in first-round presidential elections Oct. 4. Yields on 10-year government bonds plummeted by 1.3 percentage points.
Markets were also enthused by Flávio's Liberal Party nearly doubling its Senate seats and advancing in the Chamber of Deputies. "We saw a right-wing tsunami in Congress," says Roberto Simon, a Brazil-based fellow at the Stimson Center.
A runoff election is set for Oct. 25. Equities could keep rallying to 30% above pre-election levels, Czerwonko predicts. Interest rates could slide from 13.75% to 10% over the next 18 months, propelling more big gains in bonds, says Thierry Larose, portfolio manager for emerging markets local debt at Vontobel Asset Management.
It won't be easy, though.
Lula is leaving behind a debt "snowball," Larose says. Budget deficits close to 10% of gross domestic product have pushed the central bank, scarred by past hyperinflation, to maintain vertiginous interest rates, which balloon the cost of servicing the debt. Interest payments eat up about 35% of current revenue, he says.
Halting the vicious cycle would take budget cuts amounting to 2% of GDP every year for "a while," Larose estimates. That level of contraction risks a politically unpalatable recession, argues Arthur Budaghyan, head of core macro at BCA Research.
More than 90% of Brazil's state spending is constitutionally mandated through indexation schemes that tend to outstrip revenue, adds Elizabeth Johnson, managing director of Brazil research at TS Lombard. Much of the rest is divvied up among legislators to spend as they see fit. "Congress has a new power of the purse and won't want to give it back," Roberto Simon comments.
Flávio isn't personally popular. "The election was more a negative plebiscite on Lula," Larose says. Nor has he shown much interest in the fiscal issues that obsess investors. "Flávio's priorities are getting his dad out of jail and amnesty for the Brasília rioters," Johnson says, referring to Jair Bolsonaro supporters who tried to violently overturn the 2022 election results.
Market watchers are still looking for a sort of vibe austerity, where the new Congress would signal enough discipline for the central bank to ease rates, which would juice growth and make more austerity easier.
The Bolsonaro family's close ties with U.S. President Donald Trump's circle spell "less worries about surprise negatives" from Washington, like new tariffs or sanctions on Brazilian banks, adds Christopher Kushlis, chief emerging markets fixed-income macro strategist at T. Rowe Price. "Brazilian rates and currency are one of our higher convictions in EM," he says.
Slowing the debt snowball could shift markets' focus to the achievements of Lula's concluding term, like lifting oil production by half to 4.5 million barrels a day, or a revenue-raising tax reform that kicks in next year.
Just don't expect any Brazil boom to last forever. "With a Flávio win you'll see a rally, then a selloff maybe mid next year," TS Lombard's Johnson predicts.
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