Wall Street braces for two wildly different results in Brazil election

With the first round of Brazil’s presidential election taking place Sunday, Wall Street is gearing up with starkly different market predictions depending on the outcome of the neck-and-neck race.

“The Brazil trade is: Does Lula win or does Bolsonaro win?” said Fernando Marengo, chief economist at Black Toro Global Investments.

Those names should sound familiar. Lula is 80-year-old leftist Luiz Inacio Lula da Silva, who is running for a fourth term against 45-year-old right-winger Flavio Bolsonaro, son of former President Jair Bolsonaro. If neither candidate gets more than 50% of the vote, a runoff will take place Oct. 25.

In short, if Bolsonaro wins, Wall Street expects a rally in the country’s bonds, currency and stocks.

As Bolsonaro has come from behind in the last few months, Brazilian stocks have moved higher along with his poll numbers. In a recent note to clients, JPMorgan noted that the MSCI Brazil “rose by 0.25% on average each day that Flavio gained in the polls.”

Kalshi markets now show Bolsonaro favored to win 60% to Lula’s 39%. Prediction markets are prohibited in Brazil, so they may not reflect local sentiment. In a note to clients, Aurora Macro Strategies senior advisor Richard Lapper said, “the balance has shifted toward Flavio over the past month, but not nearly as far as the prediction markets are pricing.”

Bolsonaro is the favored candidate of the markets because he’s promising more fiscal discipline, something many economists say Brazil desperately needs. Debt-to-GDP stands at 81.9%, up 10% since Lula took office.

“We need a 3-3.5% fiscal adjustment to stabilize the public debt in relation to GDP,” said Leonardo Porto, Brazil head economist for Citi. And it can’t just come from one-offs like privatization of state assets, he said. “Brazil needs a permanent fiscal adjustment.”

That means cutting spending or raising taxes — either of which will be difficult. Roughly 90% of Brazil’s budget is mandatory, some of it required by the constitution. At 32%, Brazil’s tax burden is already the highest in Latin America, according to the OECD, and its prospects for growth are low.

But there’s a lot to be gained if Bolsonaro wins and manages to implement a “robust reform agenda,” said JPMorgan.

The firm looks to what happened under his father Jair when he was in power from 2016 to 2020. Bolsonaro Sr. managed to pass pension reform, which saved hundreds of billions of dollars. It imposed a minimum retirement age of 65 for men and 60 for women. Previously, men could retire at any age after working for 35 years, and women could retire at any age…