BNY Mellon

Brazilian Elections: Expect The Unexpected

The first round of Brazil's presidential election takes place this Sunday, Oct. 2. Contrary to what is priced, we believe the likelihood of incumbent President Jair Bolsonaro winning the second round against ex-president Luis Inacio Lula da Silva on Oct. 30 is close to 50-50. Our three working scenarios for a second-round vote: Bolsonaro wins with just over 50%; Lula wins with less than 55%; and Lula wins with more than 55%.

In Brazil, a president is elected if a candidate wins more than 50% of the valid votes outright in the first or second round. If a candidate fails to reach 50% in the first round, a second round takes place within four weeks between the two leading candidates in the first round. The most recent poll published by aggregator XP/Locomotiva has Lula at 49%, Bolsonaro at 38%, Ciro Gomes at 6%, Simone Tebet at 5%, and others at 1%.

For context, each of the presidential result scenarios proposed above has materialized in the past. Back in 1994 and 1998, President Fernando Henrique Cardoso (FHC) won in a first round twice, with 54% and 53% outright. Since then, however, no candidate has managed to win in a first round. Nevertheless, Lula won in the second round in both 2002 and 2006 with more than 60% support. Dilma Rousseff comfortably won in 2010 with 56% of the vote in the second round of 2010, but just barely in 2014, with 51.6%.

In the 2018 elections, while it was clear that Bolsonaro would win in a second round, he only received 55% of the vote. That was a wide margin, but still resulted in a fragmented congress that has proved quite challenging for the president and his cabinet to navigate.

In terms of market reaction, we think a Bolsonaro win will likely drive the BRL stronger, back below 5.00 per dollar, and begin to have more easing priced into the curve through 2023. The curve is priced for 300bp of easing over 2023, with -100bp priced for H1 that year.

A Lula win will likely also induce the market to price easing, but that will likely differ between the two scenarios. A 'weak win' will likely have Lula opt for a pragmatic cabinet earlier, potentially bringing ex-Finance Minister and ex-central bank (BCB) President Henrique Meirelles into the newly formed government. We believe this would, in turn, reinforce the commitment to the spending ceiling introduced by President Michel Temer, which was strongly supported by Meirelles two weeks ago. While the BRL may not rally as much on a Bolsonaro win, CDI futures could price even more aggressive easing than were Lula to win.

A strong win – 55%+ margin – for Lula will likely drive the BRL weaker, while also have additional rate cuts priced for next year. Market turmoil could escalate, however, were the president to announce intent to eliminate the spending ceiling, as frequently mentioned in public speeches over the past few months. Lula’s campaign economist, Guilherme Mello, discussed this yesterday, though didn't give details on a replacement mechanism.