Market Comment - Brazilian elections: a seismic shift underway

News item -

Sunday’s first round of Brazil’s presidential election marked a clear victory for far-right candidate Jair Bolsonaro. Brazilian equities surged on Monday, as investors cheered Bolsonaro’s victory.

The Brazilian real gained versus the US dollar and yields on Brazilian government bonds, moving inversely to prices, fell. Despite the uncertainties surrounding Brazilian politics, Fidel Kasikci, fixed income portfolio manager at ABN AMRO, believes that a positive view on emerging market debt remains warranted.

On Sunday, Brazilians went to the ballot box for the first round of the presidential elections. In addition, Brazilian voters had to choose members of Congress (all seats in the Chamber of Deputies and two-thirds of the 81 senate seats). Both the presidential and congressional elections marked strong results for Bolsonaro and his Social Liberal Party. In the second round of the presidential election – on 28 October – Bolsonaro will face left-wing candidate Fernando Haddad as his opponent.

This year’s elections are taking place against a background of strong social unrest – fueled by an economic crisis in 2015-2016, corruption scandals (many of which directly linked to high-level politicians), rising crime rates (including record homicide levels in 2017) and high income inequality. Tensions heated in the months ahead of the elections, laying bare a deeply divided country.

Dramatic battle for the presidency

The presidential battle took a dramatic turn in April, when former President Luiz Inácio Lula da Silva – or ‘Lula’, as most Brazilians call him – was imprisoned to serve a 12-year sentence for corruption. Lula, who was determined to run for office again, enjoyed a comfortable lead in the polls (and maintained his lead when in prison). At the end of August, however, the Brazilian Supreme Court barred Lula from the presidential candidacy because of the corruption conviction. From his prison cell, Lula appointed Fernando Haddad to run in his place as the left-wing Workers Party’s presidential candidate.

Haddad, a former minister of education with a PhD in philosophy, lacks Lula’s popularity. Despite his remarkable comeback in the polls during the weeks ahead of the election, Haddad kept lagging behind competitor Jair Bolsonaro of the right-wing Social Liberal Party. Bolsonaro, a former army officer, has become a polarizing figure in Brazilian society: his degrading remarks about women, gay and black people have sparked strong controversy, reflected in protest marches and social media initiatives against his candidacy such as the movement around hashtag #elenão (‘not him’). In a grim turn of events, Bolsonaro was stabbed during a campaign rally. The presidential candidate spent several weeks in a hospital before his release at the end of September.

Overwhelming victory in first round

Despite the controversies surrounding him, Bolsonaro’s shoot-first-ask-questions-later approach to crime and his promise to crack down on corruption have earned him a strong electoral base. On Sunday, he won 46% of the votes. Haddad came in second with 29% of the votes, ahead of other main candidates including Ciro Gomes (12%) and Geraldo Alckmin (5%). The second election round will be a run-off between Bolsonaro and Haddad. Although Bolsonaro’s overwhelming first-round win signals the likelihood of a victory in the second round, it is not a done deal yet: Brazilians who initially did not vote for either Bolsonaro or Haddad will play an important role in determining who will be the next president of Latin-America’s largest economy.

Fidel Kasikci

Fidel Kasikci, fixed income portfolio manager at ABN AMRO, points to the high levels of rejection rates for both candidates and the fact that none of the two parties has a majority in Brazil’s parliament: “This means that both candidates have to turn towards the two key centrist parties – PSDB and PMDB – to enlarge their appeal ahead of the second round. As a consequence, both PSDB and PMDB will play a decisive role not just in terms of deciding who wins the second round, but also in terms of defining the post-election legislative agenda.”

Seismic shift to the right

If Bolsonaro were to win the second round, it would mark a seismic shift to the right after four consecutive elections won by the left-wing Workers Party. According to Kasikci, financial markets would welcome such a shift in Brazil’s political landscape: “A victory for Bolsonaro would clearly be a positive market signal, as this candidate has explicitly supported fiscal austerity which is a strong precondition for the much-needed pension reform that both centrist parties are also favoring. Without pension reforms, the country would face another fiscal crisis as the cost of the deficit in the public system is immense.”

Kasikci acknowledges that Bolsonaro is a controversial figure: “Besides his offensive remarks about women and minorities, Bolsonaro has spoken fondly of the dictatorship that ruled Brazil from 1964-1985, which makes you wonder about his democratic principles. From an investor’s point of view, however, his victory would be positive. If a Bolsonaro victory would coincide with a long overdue sustained upswing in the business cycle, it may spur markets even long after the elections.”

A Haddad victory, which cannot entirely be ruled out yet, would likely have a negative effect on market sentiment. Kasikci: “If Haddad wins, we would face another round of market jitters, as investors would fear further fiscal deterioration under a weak government. Pardoning Lula could also be on the agenda, as Haddad owes him much of his political success.”

Positive view on emerging market debt

From a fixed income perspective, Kasikci maintains an upbeat view on emerging market debt: “We maintain our positive view on emerging market debt and believe that the current uncertainty surrounding the Brazilian elections will not unravel the strong case for investing in emerging markets. When looking at Brazil specifically: whatever the outcome of the elections may be, it will at least reduce uncertainty. And if we look at emerging markets across the board: solid growth in advanced economies (and in Asia) is still supporting emerging market exports, while currency depreciations make several emerging economies more competitive. Therefore we prefer a diversified exposure to emerging markets.”