Brazil election: Lula's surprise win rattles markets

Lula's unexpected re-election has increased fiscal risk premiums and delayed Brazil's expected monetary easing, although Congress and the central bank could constrain policy.

• Lula defeated Flavio Bolsonaro 51.8% to 48.2% on 25 October, overturning expectations formed after Bolsonaro led by more than two million votes in the first round.
• The Brazilian market fell 20% in US dollar terms on the following Monday and remained about 8% below its pre-first-round level.
• Brazil's fiscal deficit is close to 9% of GDP and public debt is near 85% of GDP, while long-term government yields rose from roughly 13% to around 14.8%.
• Markets had expected short-term rates to decline toward 12% over the next twelve months, but easing is now likely to pause until the fiscal outlook becomes clearer.
• Right-wing parties retained majorities in both houses of Congress, while MSCI Brazil trades at roughly 7.8 times forward earnings versus a historical range of 10 to 11 times and about 9 times for emerging markets.

Takeaway: Brazilian valuations may remain under pressure until Lula appoints a credible cabinet and presents a credible fiscal strategy, while exporters could benefit from lower US dollar costs after the currency depreciation.