Lula's unexpected win in the second round of Brazil's presidential election caught investors who had bet on the right-wing candidate off guard, setting the stage for a large-scale selloff in Brazilian assets.
On Monday, ETFs tracking Brazilian stocks plunged as much as 16% in the Japanese market, the biggest single-day drop since 2020; in the A-share market, the Brazil ETF Huaxia and the Brazil ETF E Fund both hit their lower price limits at the opening auction. Meanwhile, currency derivatives contracts on the CME exchange showed the real at 5.55 per U.S. dollar, implying a decline of more than 10% from Friday's close. Traders in Sao Paulo expect the selling after Monday's open to be extremely fierce, with the market possibly triggering circuit breakers.
The election result has completely overturned the "Bolsonaro trade" that took shape after Bolsonaro's first-round lead earlier this month, a setup in which billions of dollars of foreign capital poured in and institutions including UBS, Morgan Stanley, JPMorgan and Citi turned bullish on Brazilian assets. That could now reverse overnight.
Election Result Surprises Markets, Leaving Investors Unprepared
According to Brazil's electoral court, after nearly all votes were counted on Sunday, Lula won 51.8% to Flavio Bolsonaro's 48.2%, securing a record fourth presidential term. The losing side refused to accept the result; according to CCTV News, Flavio Bolsonaro said he would seek to have the election annulled.
Earlier this month, Bolsonaro's unexpected lead in the first round triggered a powerful rally in Brazilian assets that drew billions of dollars of foreign inflows. Investors had hoped Bolsonaro would pursue fiscal austerity, opening room for future interest rate cuts. Institutions including UBS Global Wealth Management, Morgan Stanley, JPMorgan and Citigroup had all issued bullish ratings on Brazilian assets.
Lula's victory, however, suddenly shattered that logic. According to Bloomberg, Anna Wu, investment strategist and founder of Floodlines Research, said: "The market was completely unprepared for this. What we are seeing in Tokyo is the unwinding of the election trade: the rally after the first round has been erased almost in an instant. In my view, this is not just a knee-jerk reaction, because the local market now faces real risks from government debt and a weakening currency."
Analysts Warn Real May Fall More Than 10%, Bond Yields Set for Violent Swings
Several market participants issued clear warnings about how Brazilian assets would trade on Monday.
According to Bloomberg, Brendan McKenna, emerging-market strategist at Societe Generale in New York, expects the real to fall 8% to 10% tomorrow, with local bond yields possibly swinging by 150 to 200 basis points. He said Lula's surprise victory would, at least in the short term, sharply reduce investor optimism toward Brazil.
A Citigroup survey of 73 investors published on Friday showed that most respondents expected the real to fall at least 5% and swap rates to rise by more than 1 percentage point if Lula won, as rate-cut bets built on Bolsonaro's first-round lead faced full unwinding pressure.
Brokerage Monte Bravo had previously estimated that if Lula won, the benchmark Ibovespa index could plunge 11% in the first hour of trading. Bruno Funchal, chief executive of Bradesco Asset Management, which manages 1.1 trillion reais (about $221 billion) in assets, said: "Monday is going to be a difficult day. The market will reprice everything. Everyone was caught off guard, and everyone is trying to figure out what exactly happened."
Circuit Breakers May Be Triggered, Derivatives Market Also Has Trading Limits
With violent swings potentially looming, the market's risk-control mechanisms will be put to the test.
Under the rules, when Brazil's Ibovespa stock index falls 10% or more, a circuit breaker is triggered and trading is halted for 30 minutes; if the decline widens to 15% after trading resumes, the market is paused for another hour; if the drop reaches 20%, exchange operator B3 decides how long the halt will last. The last time the Brazilian stock market triggered a circuit breaker was in early 2020, when the COVID-19 pandemic hit global markets.
In the derivatives market, one of Latin America's most liquid asset markets, there is no circuit breaker in Brazil, but trading limits apply: swap rates are capped at moves of 90 basis points in either direction, and currency futures are capped at moves of 6% in either direction. Once those limits are hit, trading effectively stops, and the exchange must authorize a wider trading range before it can resume.
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