Brazil's real and stocks fall below pre-election rally levels after Lula's win

The real and the Ibovespa now sit below their 2 October levels, before the first round rally began. The Treasury has cancelled three auctions and is buying back inflation linked debt at real yields of 7.3% to 7.7%.

Brazilian assets now trade below where they stood on 2 October, before Flavio Bolsonaro's first round surprise lifted them. Lula won on Sunday, and the real and the Ibovespa fell hard on Monday and recovered only a little on Tuesday.

The sell off was larger than an unwind of that rally. Part of it looks like a fiscal risk premium, a higher price for lending to the state. The Treasury has cancelled bond auctions and bought back its own debt, which fits a state that sees the pressure in the long end.

The vote itself was narrow. The electoral court TSE put Lula on 64,256,232 votes, or 51.79% of valid votes, against 59,826,041 and 48.21% for Flavio Bolsonaro. The gap of about 4.4 million votes changed investors' assumptions about who would run the budget, even though the country itself had not changed.

How far the currency and stocks fell

The real shows the size of the move. The central bank's PTAX rate, an average of four daily survey windows, was 5.22 reais per dollar on 2 October. It fell to 4.99 on 5 October and held near 5.00 for three weeks. On Monday it jumped to 5.50.

The dollar cost 9.2% more reais than on Friday 23 October and 5.3% more than on 2 October, the last trading day before the first round. In real terms the currency lost 8.4% and 5.0%. Reuters put the move on market quotes at more than 11%.

The PTAX eased to 5.33 on Tuesday. That is still 2.1% more reais per dollar than before the first round.

The Ibovespa tells the same story. It closed Monday at 176,608, down 13.9% from Friday, its biggest one day fall since March 2020 according to Reuters.

On Tuesday it traded near 175,700 at 19:45 UTC, intraday. That is 8.5% below the 192,115 close on 2 October. The index had risen 7.7% to 206,912 on 5 October.

The market's losses now exceed the gains from the rally.

Two banks cut Brazil risk the day after the vote. Citi closed its overweight equities call and its long real position, saying "given the outcome of the election, we close our Brazil risk". BCA Research went further. It cut equities to underweight and downgraded local currency bonds and sovereign credit. It said that Lula's win ends the prospect of an orthodox government delivering structural fiscal improvement.

An unwind of crowded positions offers a less troubling explanation. Crowded trades unwind violently, and that explains a return to the 5 October level. It does not explain a real that buys 2.1% fewer dollars than on 2 October, or an index 8.5% lower. Cancelling auctions rather than selling at stressed yields fits a state that sees more than positioning.

Auctions, buybacks and yields

The Treasury acted on two days. Monday, it cancelled its 27 and 29 October auctions of inflation linked and fixed rate bonds. Tuesday, it cancelled the LFT auction too. LFTs are floating rate bonds that track the Selic policy rate. A buyback of inflation linked bonds replaced it.

The Treasury's results show it bought NTN-Bs, bonds that pay inflation plus a real coupon, in four maturities. It paid about R$16.8 billion. It took all 1,000,000 offered in the 2030 and 2040 maturities, at 7.70% and 7.46%.

It took 895,750 of the 2035s at 7.65% and 919,700 of the 2045s at 7.29%. So real yields ran from 7.70% on the 2030 bond to 7.29% on the 2045, and the curve is inverted by 41 basis points. The shortest bond pays the most.

The Treasury said it would keep monitoring conditions and act to assure the market works properly.

Short rates are high, so the extra pay for lending long is smaller than the headline suggests. The Selic is 13.75% after five cuts of 25 basis points this year. Economists in the 23 October Focus survey expect inflation to fall from 5.19% in 2026 to 3.50% by 2030. They put the 2027 to 2030 average at 3.77%.

A 2030 bond at 7.70% above inflation therefore implies about 11.8% a year in nominal terms. Focus has the Selic at 11.75% at the end of 2027 and 10% from 2028, an average of 10.4% over 2027 to 2030. The bond pays about 1.3 points a year above that path. That is the term premium investors want to hold Brazilian duration, and the Treasury just paid it.

These yields also reflect fiscal risk. The Focus survey of 23 October, the last before the result, expected a primary deficit of 0.48% of GDP in 2026. It had gross debt rising from 83.5% to 87.2% in 2027 and to 95.0% by 2030.

Higher long rates raise the cost of rolling that debt. A deficit that looked manageable at one yield looks different at another, and that is what the market is repricing.

The next decisions for investors

The choice of finance minister will give investors their next signal. Lula is weighing Vice President Geraldo Alckmin and Piaui governor Rafael Fonteles, and may keep Dario Durigan, Reuters reports. The choice is tied to whether Fernando Haddad becomes chief of staff, and Lula is likely to take his time.

A treasurer with dollar debt, or an importer paid in reais, budgeted the Focus year end forecast of 5.05. The PTAX of 5.33 is 28 centavos above it.

Covering now means paying stress prices. A hedge carries about 10 points a year, the gap between the 13.75% Selic and the Fed's 3.75% to 4%. Waiting is cheaper only if the PTAX falls back toward 5.05 before the 3 to 5 November auctions.

The Treasury's calendar puts its next LFT and NTN-B auctions on Tuesday 3 November and its fixed rate auctions on Thursday 5 November. The central bank's Copom meets on 3 and 4 November and announces on Wednesday 4 November. It is the first policy vote since the result.

If the 3 November NTN-B auction clears near 7.3% to 7.7% and Copom cuts from 13.75% on 4 November, the sell off was positioning. If the Treasury cancels again, or Copom pauses, the fiscal reading stands and the real stays under pressure.