Markets Brace for Sharp Swings No Matter Result of Brazil Vote

Investors are expecting sharp swings in Brazilian markets in the aftermath of Sunday’s elections no matter the outcome, with assets to adjust quickly as the neck-and-neck presidential race prevented traders from taking too strong a view in the lead up to the vote.

A lead of more than four percentage points for President Luiz Inácio Lula da Silva in the first-round vote would reinforce his status as a front-runner in a Oct. 25 runoff and could weigh on equities, steepen the swap rates curve, and potentially put pressure on the real, according to Mauricio Moura, co-founder of Zaftra, an investment fund focused on elections and political events.

A smaller gap — or a tie — would be seen as relatively more favorable for Flávio Bolsonaro, potentially sparking a rally on hopes the right-wing candidate would deliver a strong fiscal adjustment investors see as key.

“Orthodox fiscal policy U-turns are handsomely rewarded by the market, which is why investors remain fixated on the first round of Brazil’s presidential election,” said Natalia Gurushina, chief economist for emerging markets at Van Eck Associates Corporation. The tight polls, however, leave the door open to a selloff should the result prove “disappointing,” she added.

Read more: Follow live coverage of Brazil’s election on Sunday

Rally or Rout

Eduardo Cohn, portfolio manager at Heritage Capital Partners, built “marginal” positions that would benefit from a Bolsonaro win. He likes long-dated NTN-Bs, Brazil’s inflation-linked government bonds, seeing room for real yields to compress if the right-wing candidate prevails.

JPMorgan has estimated that a fiscal-improvement scenario could send the real about 6% higher, push local government bond yields toward 13% and lift equities as much as 50% from current levels. Under incremental fiscal deterioration, it sees the real weakening about 6%, bond yields rising toward 15.5% and equities falling 21%, according to a note from Sept. 29.

Bloomberg Economics projects a Bolsonaro win could lower 10-year yields by 70 basis points and strengthen the currency by almost 3%. Conversely, a Lula victory could trigger a jump of almost 100 basis points in long yields, and weaken the real by more than 3.5%. Crowded bets on the rates curve leave it open to a sharp reversal if the incumbent outperforms, according to Bloomberg Intelligence.

Assets to Watch

Traders looking to react to election results as soon as Sunday night will turn to Japan’s Next Funds Ibovespa Linked ETF, which tracks the benchmark Ibovespa index. Currency derivatives at the CME exchange could also move on the vote.

As European markets open, attention may shift to ETFs in Frankfurt and London, before pre-market trading in the US-listed EWZ, starting at 4 a.m. ET.

Next Funds Ibovespa Linked ETF (Tokyo)Xtrackers MSCI Brazil UCITS ETF (Frankfurt)iShares MSCI Brazil UCITS ETF USD Dist (London)Lyxor MSCI Brazil UCITS ETF (Paris)iShares MSCI Brazil ETF (New York)Franklin FTSE Brazil ETF (New York)Direxion Daily MSCI Brazil Bull 2X Shares (New York)ProShares UltraShort MSCI Brazil Capped (New York)

Local trading begins at 9 a.m. Sao Paulo time, with the currency, swap rates and equity futures. Stocks open at 10 a.m.

Credit

Some of Brazil’s government and corporate dollar-denominated bonds are traded in European exchanges and may see price action. Credit default swap contracts trade all day, although liquidity is thinner outside of US hours.

BRAZIL 3 ¾ 09/12/31BRAZIL 7 ⅛ 01/20/37BRAZIL 5 ⅝ 01/07/41PETBRA 6.85 06/05/2115PETBRA 5.6 01/03/31VALEBZ 3 ¾ 07/08/30BRAZIL CDS USD SR 5Y D14

Stocks

In the event of a Bolsonaro win, Citigroup Inc. favors longer-duration and domestically exposed stocks, including homebuilder Cyrela SA and apparel retailer C&A Modas SA. A revival in capital markets activity could also boost companies like B3 SA and XP Inc., according to a report. In a Lula win, Citi strategists favor “all-weather” stocks, including companies with pricing power such as Embraer SA, WEG SA and Axia Energia SA.

Stocks that could move in the early hours:

EuropePetrobrasValeUSPetrobrasValeItau UnibancoBanco do BrasilBradescoSabespGerdauCSNCemigEmbraerAmbev

Shares of companies with significant exposure to Brazil could also be active:

AsiaBYD, Hana Micron, Nihon NohyakuEMEACarrefour, AB-InBev, Santander, Telefonica, Telecom Italia, EDP, Stellantis, Mapfre, IberdrolaNorth AmericaMercadoLibre, NU, StoneCo, XP, PagSeguro Digital, PicPay, Agibank, JBS, Inter & Co, Arcos Dorados, Afya, Coca-Cola FEMSA