Analysis-Investors confident in Brazil staying the course after election By Reuters

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Foreign investors are undaunted by the prospect of a leftist former union leader replacing Brazil’s rightist president and ripping up the most significant fiscal guideline in the world’s 10th largest economy.

Their calm confidence in Brazil is reflected in the fact that the local currency and stock market have risen this year, despite the country’s upcoming very divisive election.

There is widespread agreement amongst pollsters that former president Luiz Inacio Lula da Silva will defeat incumbent Jair Bolsonaro in October’s election, maybe even on Sunday’s first round vote, and will thus assume office in January.

According to Amer Bisat, BlackRock (NYSE:head )’s of emerging markets fixed income, “we have a broadly positive medium-term view on Brazilian investment opportunities,” citing the country’s enticing blend of high corporate earnings, a sound financial system, large foreign reserves, and a current account surplus on the back of robust commodity exports.

Both Lula and Bolsonaro promise more generous welfare and more flexible budget regulations, although Lula, whose Workers Party followed a mostly conventional route when in government from 2003-2010, has criticised Bolsonaro’s plans.

In his first term, Lula spent lavishly on social initiatives thanks to a government budget that had grown larger due to the commodities boom. He will have less money this time around, and he has already pledged to eliminate the expenditure limit set by the Constitution.

Amundi’s head of developing markets, Yerlan Syzdykov, expressed concern at a recent event that Lula was not honouring Brazil’s present budgetary anchor.

However, neither did Bolsonaro during the past two years, so this is not surprise investors.

It would not be a major change in regime, he said, given Lula’s record on economic policy.

Bonds denominated in both local currency and hard currency are among the best performers in their asset class, and the Brazilian real is one of the few emerging market currencies rising against a dollar that is generally at multi-decade highs.

Spreads of Brazilian sovereign debt over U.S. treasuries (Graphics)

Also, the local stock market is up for the year and only slightly down in dollar terms, bank balance sheets are strong, and hiring is on the upswing, all while inflation is decreasing owing to early and aggressive interest rate rises.

The central bank “as an autonomous institution has demonstrated its legitimacy by being one of the early global central banks to battle inflation with force and determination,” BlackRock’s Bisat said.

Chief of the central bank Roberto Campos Neto, whose tenure extends until 2024 thanks to a new law giving the bank official independence, has presided over a series of rate rises that have helped prop up the real by coming before the U.S. Federal Reserve.

Despite complaints from Workers Party economists about the central bank’s increased autonomy, Lula has said he is willing to cooperate with Campos Neto.

Graham Stock, senior emerging sovereign strategist at BlueBay Asset Management, emphasised the opportunity for Lula and his team to show they respect the bank’s independence and inflation targeting regime, arguing that “it’s important that he (stay) because otherwise what’s the point in having a mandate for the central bank governor that’s independent of the political cycle.”

Pictures: New World Currencies vs. the Dollar

Goldman Sachs (NYSE:) described the central bank’s decision to stop rate hikes last week as a “hawkish hold,” after the rate had been raised from a record low of 2% at the beginning of the year to 13.75%, with future guidance indicating a “high for long” posture.

To investors, Philip Meier, head of EM debt at Gramercy Funds Management, described Brazil as a “fantastic opportunity” through 2023 due to its “unheard of” high real rates.

Brazil’s real has gained 4% against the dollar so far this year, making it the best-performing freely traded emerging market currency despite the fact that the dollar is near 20-year highs against a basket of other currencies.

Not all investors are so upbeat, though. JPMorgan (NYSE:) downgraded foreign-denominated Brazilian debt to “underweight” earlier this month, indicating that the country’s potential for future credit market gains abroad may be constrained.

Policy and political uncertainty are expected to linger ahead of the October elections, and fiscal/debt dynamics remain a worry, according to Lupin Rahman, head of sovereign credit on the EM markets portfolio management team at Pimco.

Year-to-Date Performance of MSCI Stock Indices: Graphics

Investors in the MSCI Brazil index pay about $6 for every $1 in profits, a significant discount from the top valuation of about $18 in 2020.

Financial backers prefer a peaceful political changeover. Bolsonaro has set the stage for a possible recount, but Brazilian institutions are banding together to protect the validity of the vote.

If Lula receives more than 50% of legitimate votes on Sunday, the two-man race will end there, and there will be no need for a runoff election on October 30 between Lula and Bolsonaro. The ex-union leader is within shouting distance, according to a number of recent surveys.