Brazil's capital markets are crashing

Very few investors had this on their radar: Brazil's left-wing President Luiz Inácio Lula da Silva was surprisingly able to turn things around and was elected to a fourth term in office with a lead of over four million votes. His right-wing challenger Flávio Bolsonaro won the first round of elections at the beginning of October.

Brazilian capital markets collapsed because of the result. Double-digit losses are expected when the Sao Paulo stock market opens this afternoon. Index funds based on the leading Bovespa index lost up to 25 percent in the morning. Brazilian government bonds are also under heavy pressure, while the local currency, the real, is trading more than eight percent lower against the dollar.

The financial markets reacted euphorically to the first round of elections. They had opted for a more business-friendly course under a Bolsonaro government. On October 9th, the Bovespa jumped over 200,000 points for the first time in its history. Last but not least, the shares of the oil giant Petrobras had risen sharply in the hope of lower environmental regulations.

Brazilian bond prices also rose significantly in hopes of greater fiscal discipline under a new president.

Now there are concerns about further increases in government spending and escalating debt. Under President Lula, Brazil's national debt has reached almost 83 percent of gross domestic product. Observers such as the World Bank warn that under the government's continued spending policy, the debt ratio could soon reach the extreme level of 100 percent.

The fact that Bolsonaro, who is supported by US President Donald Trump, does not want to recognize the election results is unlikely to bring calm to the markets.

"The most important signal for the markets will be the Lula government's future commitment to fiscal discipline," commented Graham Stock, bond strategist at London-based fund provider RBC Bluebay Asset Management. “At the top of the agenda is the appointment of a new finance minister in the coming weeks.” Moderate Vice President Geraldo Alckmin was given a prominent role in Lula's victory celebrations last night, raising hopes that he could steer economic policy in a more conservative direction.

“We are of the opinion that even a Lula government will not be able to avoid taking at least certain measures for budget consolidation,” said Thierry Larose, portfolio manager at the private bank Vontobel.

The EU Commission in Brussels was relieved about the election outcome. EU Commission President Ursula von der Leyen congratulated Lula on his re-election. The head of state is open to the Mercosur trade agreement, which is “good news for us,” said investment strategist Stephan Riße from the Acatis fund company.

Lula's re-election is also good news for the global climate. Lula put an end to the slash-and-burn practices in the Amazon region pushed by his predecessor Jair Bolsonaro. According to Riße, slash-and-burn agriculture and deforestation in the region have recently reached their lowest level in four years.

Investors can look forward to a countermovement on the German stock market. Supported by a robust ifo index and falling oil prices, the DAX gained 0.9 percent to 25,415 points by the early afternoon. Last week the leading index lost 1.7 percent.