Brazil’s Markets Are Tanking as Traders Watch Lula Support Rise

(Bloomberg) -- With less than two months to go before Brazil’s presidential elections, investors are coming to grips with the idea the result may not be what they want.

Former President Luiz Inacio Lula da Silva’s support rose in all three major polls that came out last week, horrifying traders who dread the return of his Workers’ Party to the presidential palace in Brasilia. If allowed to run despite being in jail for a corruption conviction, Lula would win a runoff round against all candidates with as much as 53 percent of the ballots, the polls showed. Even if he’s knocked off the top of the ticket, his likely replacement -- former Sao Paulo Mayor Fernando Haddad -- is also feared by investors.

Market-favorite Geraldo Alckmin failed to gain much traction in the polls, mired near the bottom with half a dozen other candidates. While it wasn’t a huge change from weeks past, investors who want the next government to shore up its finances and avoid heavy-handed state intervention in the economy had been hoping for signs of fading enthusiasm for Lula.

So traders’ response was to sell, fast. The currency plummeted 4.7 percent last week to its lowest since early 2016, the worst performance in emerging markets. Volatility is higher than it was at the same point in the past three elections, though still short of the level seen when Lula first won the presidency in 2002. The iShares MSCI Brazil exchange-traded fund has had more than $700 million of outflows in August, a record.

Workers’ Party Calculus

“Brazil remains a paradox,” said Sean Newman, a portfolio manager at Invesco Advisers in Atlanta. “In an election where no one seems to care about candidates, all want less corruption but favor the man behind the biggest debacle in the country’s history.”

The real rose 1 percent Monday to 4.0635 per dollar, while the Ibovespa stock index added 1.6 percent as of 11:40 a.m. in New York.

While Lula is unlikely to be allowed to run due to his corruption conviction, the uncertain timing on when exactly the courts will bar his bid -- and how long the appeals could drag on -- is adding to the sour mood. The thinking is that the longer Lula can stretch it out, the more enthusiasm he can whip up for the Workers’ Party and, by extension, Haddad, currently the party’s vice presidential candidate.

Haddad has just 4 percent of voter intentions, but hardly anyone knows who he is outside Brazil’s biggest city. Forty percent of Brazilians have never heard of him, according to Datafolha, but about 30 percent say they will definitely vote for whomever Lula endorses. Another 18 percent said they also might.

The most pessimistic analysts see the currency sinking 25 percent to 5.5 per dollar and stocks losing a third of their value in the event a candidate not committed to reforms wins.

Bradesco BBI analysts forecast a 35 percent chance the next administration carries out a deep fiscal adjustment to shore up finances, which could spark a 58 percent rally in the Ibovespa by year end. The gauge could just as easily lose a fifth of its value with no fiscal adjustment at all, a scenario the analysts assign a 30 percent chance of happening.

Glory Days

Lula’s term from 2003 to 2010, which coincided with a massive rally in commodity prices, turned out to be great for markets: stocks surged sixfold and the currency rallied 113 percent. A good part of those gains, however, was erased during the presidency of Dilma Rousseff, his hand-picked successor. Her government tapped government finances to try to keep growth going as the global economy soured, resulting in eroding fiscal accounts and spiking inflation.

It’s been unclear if Haddad would follow Lula’s more pragmatic approach or Rousseff’s interventionist ways. While the party’s official platform references capital controls and suspending privatizations, Haddad has been striking a softer tone in meetings with bankers, according to local media reports.

An article he wrote for literary magazine Piaui last year might have some hints as to his governing philosophy. Haddad, who holds a master’s degree in economics and a doctorate in philosophy with studies about the Soviet Union and Marxism, describes himself as a calm, focused man, who learned early on how to negotiate and talk things out.