By Rodrigo Campos and Marcela Ayres
NEW YORK/BRASILIA, Oct 26 (Reuters) - Brazilian President Luiz Inacio Lula da Silva won reelection on Sunday, defeating right-wing Senator Flavio Bolsonaro and setting up a test for financial markets, with investors expecting recent bets on a change of government to unwind in a volatile week ahead.
November futures for the Brazilian real were down 10% in Asian hours while a Tokyo-listed Brazilian stock exchange-traded fund, the Nomura NF Ibovespa Link ETF, plunged
15%.
Markets had moved sharply in anticipation of a right-wing shift since Bolsonaro, the son of convicted former President Jair Bolsonaro, unexpectedly finished first in the opening round three weeks ago.
Stocks closed on Friday almost 7% above their level going into the first round, while the real currency was nearly 5% stronger against the US dollar. Interest-rate futures had indicated expectations that tighter public finances would allow borrowing costs to decline.
"We expect a sharp market reaction on Monday, with aggressive repricing, a selloff in assets and interest rate futures likely to hit their upper limit shortly after the open," said Luis Felipe Vital, head of macro strategy at Warren Investimentos.
Over the next four years, Lula must slow the growth of Brazil’s debt while protecting social programs and investment. For investors, the question is whether his gradual approach to fixing public finances can bring borrowing costs down.
Without confidence that he can deliver, lenders could demand higher interest rates, adding to the government’s debt and making credit more expensive for businesses and households.
"Investors want a clear and credible commitment to fiscal discipline," said Alejo Czerwonko, chief investment officer for emerging markets at UBS Global Wealth Management. "We expect the rally that followed the first round to be largely priced out, and sentiment to stay weak until a clear fiscal plan emerges."
Czerwonko said investors are looking for a halt to the spending that accompanied the campaign and a believable path to stabilize public debt. "It also means a working relationship with an opposition-leaning Congress, because no fiscal plan passes without it," he said.
Lula’s team aims to produce a budget surplus before interest payments of about 1.3% of gross domestic product by 2030. That would leave money to cover part of the interest bill, reducing the need for fresh borrowing. But public debt already exceeds 82% of GDP, while pensions and other legally required spending limit where savings can come from.
"Lula's policies have talked about spending cuts, but he's not gone into the details of how that is going to look like," said Divya Singaravelu, head of research at Meridian 1305 Capital. She said the choice of the next finance minister would be an early signal to markets, adding: "We want to see what the 2027 budget and spending cap looks like."
Whoever takes the job will need to explain how campaign commitments fit within those fiscal limits.
"The key point is that, even if pessimism prevails in the near term, investors will need to watch how the government's economic agenda advances over the medium term," said Gustavo Sung, chief economist at Suno Research.
"The main thing to watch now is how the government organizes itself for 2027."
(Reporting by Rodrigo Campos in New York and Marcela Ayres in Brasilia; Editing by Aurora Ellis and Lincoln Feast.)
