Brazilian elections: The calm before the storm?

  • Unlike in previous elections, there are few signs of politically driven stress on Brazilian markets. Yet, Brazilian markets are in for a reality check in 2023. The results of the first round of the Presidential elections have reduced the likelihood of extreme policies: markets are familiar with both candidates. Investors have also welcomed the commodity boom and the determination with which the Central Bank of Brazil has acted (positive real interest rates, resilient real and net portfolio inflows). In 2023, once major central banks start to pivot and markets readjust their yield expectations, Brazilian sovereign bonds should yield positive returns. In the hard-currency environment, this will come from the reduction in the risk-free rate rather than by the spreads, where we expect a slight widening (above 300bps in 2023) as oil prices adjust further and concerns of fiscal policy grow. The first rate cuts and the control of inflation should bring yields of BRL-denominated bonds slightly down, but we do not expect them to go much below 11% in 2023 for the 5Y bond. Credit should benefit from easing monetary policy but fundamentals will keep spreads wider than necessary (~400bps). For equities, short-term cyclical momentum will feed into 2023 (~0-5% yearly return) but will start losing steam by year-end due to lower structural economic growth beyond 2023.
  •  Public debt is the true winner of this election. Investors will be watching for fiscal soundness. Beyond what comes next from the Federal Reserve and from oil prices, domestic fiscal policy will play a crucial role. We analyze the programs of both candidates Lula and Bolsonaro and find that the expansionist measures (social transfers, tax cuts, yet another revision of the spending cap) would lead to a deterioration of the primary fiscal deficit to -1.9% of GDP in 2023, the worst in 20 years (excluding the pandemic). This also means that Brazil will reach a 100% debt-to-GDP ratio by 2026. In addition, some fiscal measures may cause more inflation: We expect headline inflation at 5.1% in 2023, against the central bank’s target of 3.25%, while real GDP growth will weaken to +0.8% in 2023 and return to close to its potential in 2024 with 1.9%. We expect the BCB to hold the Selic rate at 13.75% in 2022 and to start to lower it in H2 2023, bringing interest rates to 12% by the end of the year.
Pablo Espinosa Uriel
Allianz SE
Roberta Fortes
Allianz Trade
Jordi Basco Carrera
Allianz SE