Brazil stocks, real tumble as Lula win ends bullish run

Brazilian stocks and the real currency slumped after the surprise reelection of President Luiz Inacio Lula da Silva as the bullish investor sentiment which followed his right-wing rival's success in the first round of voting evaporated. Brazil's real tumbled nearly 12% against the US dollar in early spot trading, one of its ‌biggest daily moves on record, while Bovespa stock index futures fell nearly 15% and interest rate futures rose.

The selloff hit Brazil's sovereign debt, with longer-dated bonds hit hardest and the 2056 maturity down around 2.5 cents. Meanwhile, trading on Brazil's stock exchange was halted for 30 minutes after the benchmark Bovespa index fell 10% from its last close, triggering the market's circuit breaker mechanism, stock exchange operator B3 said in a statement.

The move came after B3 initially expanded the daily trading limits for ‌Bovespa stock index futures, dollar futures and interest rate futures in response to heightened market volatility. Brazil's five-year credit default swaps, a measure of the cost of insuring against sovereign default, jumped to 151.67 basis points from Friday's close of ‌120.21, S&P Global Market Intelligence data showed.

As markets tumbled, the Brazilian Treasury cancelled its regular auctions of inflation-linked and fixed-rate government bonds scheduled for October 27 and October 29, respectively. Prices of raw sugar, of which Brazil is a major exporter, slid nearly 5% on the collapsing exchange rate.

The plunge is a sharp reversal from the rally seen earlier this month, when markets soared on expectations of a shift to the right when Senator Flavio Bolsonaro, the son of former President Jair Bolsonaro, unexpectedly finished first in the opening round of Brazil's presidential elections. The Bovespa index had closed on ⁠Friday almost 7% above ​its level before the first round, while the real had ⁠been nearly 5% stronger against the US dollar.

Interest rate futures had also reflected expectations that tighter fiscal policy in the event of a Bolsonaro government would make room for lower borrowing costs. Prediction markets had indicated a Bolsonaro win, with Kalshi pricing in a more than 75% chance ⁠of that on Friday.

Senator Bolsonaro's refusal to concede and his pledge to seek an annulment added to investor uncertainty. "Important for local financial markets will be how quickly Bolsonaro accepts the result, or at least allows the constitution to run its course," said Chris Turner, strategist at ​ING in London.

Attention will now turn to Lula's choice of finance minister and what it signals about his fiscal approach. "The key signal for markets will be the next Lula administration's commitment to fiscal discipline, ⁠starting with the appointment of a new finance minister in coming weeks," said Graham Stock at RBC BlueBay Asset Management.

CHALLENGES AHEAD Lula faces the challenge of slowing the rise in Brazil's debt while protecting social programmes and investment, with investors looking for signs his gradual fiscal approach can bring borrowing costs down.

"(The) Lula ⁠administration ​will have no choice but to do some fiscal consolidation too, but most investors doubt it will be enough to put debt sustainability back on track," said Thierry Larose, portfolio manager at Vontobel Asset Management. Without confidence that Lula can deliver, lenders could demand higher interest rates, adding to Brazil's debt burden 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, adding that investors wanted an end to campaign-related ⁠spending and a believable path to stabilize public debt.

The reelected ⁠president's team aims to produce a budget surplus of about 1.3% of gross domestic product by 2030. "Lula's policies have talked about spending cuts, but he has not gone into the details of how that is going to look," said Divya Singaravelu, head of research at Meridian 1305 Capital.