Brazilian Markets Sink as Spending Drive Endangers Lula’s Honeymoon With Investors

Lack of clear fiscal path by the incoming government in Brazil causing investor worry

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Bloomberg — Brazil’s currency and stocks sank and swap rates jumped as investors grew increasingly concerned that President-elect Luiz Inacio Lula da Silva’s plans to boost spending will swell budget deficits and undermine fiscal accounts.

The real (BRLUSD) fell 3.4% on Thursday, its worst day since April, erasing all the gains since the presidential runoff vote on Oct. 30. The benchmark Ibovespa (IBOV) equity index dropped 3.3% and long-end swap rates rose more than 100 basis points. The declines are some of the worst in the world, bucking a global rally.

“The honeymoon with Lula is over,” said Thierry Wizman, a currency and interest-rate strategist at Macquarie Capital in New York. “A few weeks of excitement, and then real life begins.”

Investors are worried that the president-elect will push for more spending than previously expected. Lula, who was elected for a third term, is trying to open room in next year’s budget to fulfill his campaign promises, which have an estimated cost of additional 160 billion to 200 billion reais ($37 billion).

The left-wing leader further fanned concerns this week, saying that what the market calls spending he calls investment, and those who focus on fiscal rules should also discuss social issues. Later, he added he has never seen markets being so “sensitive”. His transition team is considering removing social aid programs from the spending cap rule that limits the growth of public expenditures, according to Workers’ Party Senator-elect Wellington Dias.

The current budget bill for 2023 -- which doesn’t take into account Lula’s campaign pledges -- estimates a primary deficit equal to 0.6% of gross domestic product, and XP Inc. brokerage predicts that with extra spending from Lula the shortfall will expand to 0.9%.

Brazil’s gross debt stands at around 77% of GDP. That’s lower than it was at the height of the pandemic in 2020, and it could fall a little further by the end of 2022 because of one-off revenue this year. But it’s still above pre-Covid levels and higher than that of major regional peers such as Mexico and Chile, meaning it’s of potential concern to investors.

Brazilian assets, which jumped following Lula’s election on Oct. 30, have been down most of this week as the president-elect delays presenting details of his spending plans or picking his finance chief. Local media reports saying leftist former Sao Paulo Mayor Fernando Haddad remains among the top contenders for the job and faster-than-expected inflation added to the negative mix on Thursday.

Investors including one of Brazil’s best-known hedge fund managers are voicing concern about Lula’s lack of concrete fiscal proposals. Verde Asset Management’s flagship fund built hedges in the local equity market following recent gains, with other money managers locking in profits.

“Brazil has performed very well in 2022 in general,” said Jeff Grills, head of emerging markets debt at Aegon Asset Management in Chicago. “There was limited room for it to appreciate further post election without a meaningful improvement.”

On Wednesday, Lula said he will only start considering cabinet appointments later this month after returning from a trip to Egypt, toning down expectations of imminent announcements about his government’s configuration. Lula will leave Brazil on Monday to attend the COP27 climate talks in the Egyptian resort of Sharm el-Sheikh and will return on Nov. 19.

--With assistance from Martha Beck and Walter Brandimarte

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