Market Wire: Brazil's Lula wins presidential election, shocking currency markets

Luiz Inácio Lula da Silva has pulled off a stunning upset in the second round of Brazil’s election, securing a fourth term as president, and wrongfooting currency traders who had bet on a change of economic direction in Latin America’s largest economy. Early results suggest that the 80-year-old leftist president has captured 50.6% of the vote, narrowly beating Flávio Bolsonaro, son of former president Jair Bolsonaro, who came first in the first round and held a slight lead in the polls going into the run-off.

On the face of it, the Brazilian real looks exposed to a violent selloff as currency traders revise expectations and unwind long positions. Bulls had piled into the currency in recent weeks on the assumption that a market-friendly Bolsonaro government would tighten spending rules, restore confidence in the fiscal outlook, and improve relations with the US, making Brazil the region’s most attractive destination for carry trades. Other Latin American currencies, by contrast, should find some support as Brazil becomes a less compelling rival for carry flows.

Contagion could spread across the region, however, if the result is contested or annulled. The vote was marred by chaotic conditions, with bad weather leading both campaigns to request an extension. Minutes after polls had closed in many states, the Supreme Court responded by extending voting by two hours, a move that could be seen as giving one of the candidates an unfair advantage. If Bolsonaro concedes, markets will grumble and move on. If he does not, other currencies could be caught up in a wave of risk aversion, and the real will be the least of Brazil’s problems.

The knee-jerk reaction in markets could also fade over the coming days as investors take a more nuanced view of the balance of power. Based on the results of the elections on October 4th, right-wing and centre-right parties will hold roughly 57% of the seats in the Chamber of Deputies and 62% in the Senate (about 50 of 81) when the new Congress sits – so Lula’s agenda will face meaningful constraints.

Brazil has elected a leftist president and a right-wing Congress. Gridlock is likely – and for a country facing severe fiscal challenges, that may be the best outcome of all.