Oct 26 (Reuters) - Brazilian President Luiz Inacio Lula da Silva's election victory over Flavio Bolsonaro looked set to trigger a sharp selloff in its financial markets on Monday.
Brazil's stock market hit a record high after the first round of the election earlier this month pointed to a Bolsonaro win, boosting investor hopes for a more fiscally disciplined government and a wave of pro-business policies.
MORGAN STANLEY ANALYST NOTE"The first step (in market reaction) would be simply reversing the
first-round decline in fiscal risk premia: We estimate this could be a very fast adjustment of ~200bp across the board, towards 14.50% on Jan 29 DIs (interbank rates).
"The markets are likely to price out quickly most, if not all of the ~130bp of easing priced into the front-end of the "Brazilian interbank rate) curve given first round optimism. We would expect USD/BRL to test 5.50"
"If Lula's new government doesn't commit to spending cuts in the coming weeks "then we would likely slide closer to the bear
case ... one where asset prices incorporate fiscal dominance risks. "In our view, this would translate into USD/BRL to
6.00, Jan-29 DIs (interbank rates) to 16.50% ... Market pricing would start to include rate hikes and BCB intervention to stabilize BRL would become more likely."
ABERDEEN INVESTMENTS EM DEBT DIRECTOR, VIKTOR SZABÓ
"The concern is not simply who won, but how.
"In the three weeks between the two rounds, the government brought forward a 15% increase in Bolsa Família, the flagship cash-transfer programme.
"It cut federal taxes on petrol to zero and increased subsidies for ethanol and imported diesel. Lula signed into law the forgiveness of federal tax debts owed by micro-entrepreneurs."
"Days before the vote, the government sent Congress a constitutional amendment for free public transport at weekends and on public holidays. Congress also promulgated the end of the six-day working week, one of Lula's flagship pledges.
"Taken together, they send an unmistakable signal: when votes were at stake, fiscal prudence came second."
RBC BLUEBAY SENIOR EM STRATEGIST, GRAHAM STOCK
"We expect DIs (the local swap market) and the currency to open down, circuit breakers will kick in, so I'm not sure how much trading there will be (during Monday's session).
"It depends on how Lula and his team react – the market was clearly signalling it preferred (Bolsonaro's pledges of) fiscal consolidation – so the question is how much Lula will adjust his stance.
"How that is reconciled is key, but we might not get a resolution for months, as he (Lula) will have build a coalition to work with congress ... The lesson will be that policy will have to be tighter than in his third term."
BARCLAYS ANALYST NOTE
"Lula's victory should trigger disorderly moves in local markets," Barclays analysts said in a note.
"USDBRL could initially go to the 5.50 range ...markets will be looking to the Ministry of Finance pick, along with signals about the policy agenda following the campaign promises that would point to a looser fiscal stance."
They added that Brazilian sovereign bonds could sell off around 300 basis points in the coming days, mirroring moves after the last election in 2022 when Lula announced his cabinet and less constrained spending plans.
Speculation around a contested election was "typically something markets look through, but could be in the headlines if a potential annulment is discussed."
ING STRATEGIST CHRIS TURNER IN LONDON
"Expect Brazilian markets to be hit hard. USD/BRL gapping 5-7% higher at the open to the 5.20/25 area should be no surprise, while the local Bovespa equity index looks set for double-digit losses.
"The moves could turn out to be larger if the external environment deteriorates again and US Treasury yields spike. The fiscal side has always been Brazil's Achilles heel, and a 7-8% budget deficit and 70% net debt-to-GDP ratio leave Brazil vulnerable in a global bond sell-off.
"Important for local financial markets will be how quickly Bolsonaro accepts the result – or at least allows the constitution to run its course. That is what his father did 44 hours after losing to Lula in 2022, a move that provided some calm to markets."
JPMORGAN ANALYST NOTE
On Equities – "It is important to keep in mind that circuit breakers are likely on Monday: a 10% decline in the Ibov (stock market) leads to a 30 minute market paralysis, a 15% decline triggers an additional 1 hour break, and a 20% decline gives the B3 the discretion to suspend trading for the rest of the day. We expect at least part of that to happen.
"In terms of sectors, the domestic cyclicals should fall hard, while exporters should outperform on the back of currency weakness."
JPMorgan analysts also cut their view on Brazil's government bonds to "underweight", effectively a recommendation to sell.
"Brazil’s (bond) spread outperformance vs. BB-rated peers and a greater tilt toward Eurobond financing leaves (the) sovereign credit exposed to a meaningful correction unless – and until – market pressure prompts fiscal concessions."
AVIVA INVESTORS SENIOR PORTFOLIO MANAGER, KURT KNOWLSON
"We expect a negative market reaction to Lula’s election victory.
"The announced measures by the Lula administration in the run-up to the second round mean that the starting point for much-needed fiscal consolidation is higher now.
"The reality is that Brazilian real weakness and higher long-end and real rates will again be needed to provide the disciplining mechanism, unless a credible fiscal path can be announced in short order."
CAPITAL ECONOMICS' ANALYST, WILLIAM JACKSON
"Lula’s surprise win in the second round of Brazil’s presidential election will dash hopes for reforms that would improve the public finances and strengthen growth prospects. A sharp fall in the real and equities and a rise in bond yields, more than reversing the rally since the first-round vote, are likely."
(Compiled by Marc Jones and Sruthi Shankar; editing by Alexander Smith and David Holmes)
