Brazilian stocks drop 13.9% after Lula wins re-election

Brazil's benchmark stock index fell 13.9% on Monday, marking the steepest daily drop since the start of the pandemic in 2020. The sharp decline followed Sunday's election results, which returned Luiz Inácio Lula da Silva to the presidency. This was his first re-election since serving two previous terms from 2003 to 2011. He has held office since January 1, 2023.

The market reaction also hit the currency and debt markets. The Brazilian real lost nearly 8% of its value against the U.S. dollar, the largest drop since 1999. Simultaneously, the yield on the 10-year government bond climbed 2.46 percentage points. This level is the highest recorded in more than a decade. These moves erased the gains investors had made after Flávio Bolsonaro won the first-round vote in early October. Bolsonaro had been viewed as the candidate more likely to satisfy fiscal concerns.

Lula now leads a government that must navigate a Congress dominated by right-wing members. The White House also maintains a hostile stance toward his administration. Economic conditions remain difficult for Latin America's largest economy. Growth is slowing while inflation and interest rates remain high. The president has promised several costly policies to his base. These include protecting existing benefits, raising the minimum wage above inflation, and expanding housing and education programs. He also plans to cut the standard workweek to 40 hours without reducing pay.

Rafael Ch, a senior analyst at Signum Global Advisors, noted that the election result signals an endorsement of higher social spending. Voters want tangible improvements to their household finances. However, bond markets are already wary of Brazil's rising debt-to-GDP ratio. Ch stated that markets will likely demand a higher premium if public spending increases. The Brazilian Treasury canceled two planned bond auctions for this week on Monday. The move came amid concerns over demand and soaring yields.

Elizabeth Johnson, a managing director at TS Lombard, described the potential fiscal crisis as largely of Lula's own making. She expects the government to announce measures in the coming days to calm markets. These could include curbing civil-service benefits, reducing subsidized credit, and proposing a new tax on goods like alcohol and cigarettes. Johnson said the base case is that Lula will advance a modest fiscal reform to avoid a major crisis in 2027. She added that the president must rush to approve reforms before the new legislature convenes in February.

Russ Mould, investment director at AJ Bell, said Brazilian stocks will suffer in the short term. He noted that the Ibovespa was the best-performing major stock market index this year. That rally was driven by higher commodity prices and expectations for a right-wing government. Mould warned that the recent decline could also affect wider pan-Latin American indices. The MSCI Latin America index reached a 12-year high this year, aided by the political shift that Brazil was expected to join.