Brazilian markets are experiencing reduced investor exposure as electoral concerns gain momentum, making it challenging for what has been one of the year's most profitable carry trades. Fund managers at VanEck, Vontobel, and Aberdeen are either avoiding local fixed income or reducing their exposure to the Brazilian real, citing election-related risks. Kieran Curtis of Aberdeen emphasized the move is a preparation for volatility rather than a bet on the outcome.
Polls show President Luiz Inácio Lula da Silva leading with about a 67% chance of re-election, which puts investors on alert, especially as Brazil might buck the right-leaning trend seen in other Latin American countries. The iShares MSCI Brazil ETF saw its largest daily outflow since 2013, and JPMorgan strategists downgraded Brazilian equities, preferring to avoid the uncertainty. The low level of hedge in the Brazilian real, compared to previous election cycles, suggests potential for depreciation if investors seek protection.
Local asset managers are also expressing apprehension, with electoral risks compounding concerns about fiscal deterioration and persistent inflation. Adam Capital warned that real interest rates on NTN-Bs, exceeding 8%, are "clearly unsustainable." Despite the real's approximately 6% appreciation against the dollar this year, driven by high real interest rates making it attractive for carry trades, this strength is seen as masking underlying debt challenges.
The JPMorgan report indicates a 3.5-point lead for President Lula over Flávio Bolsonaro in second-round polls. While the real has shown resilience due to carry trade interest, it remains vulnerable to shifts in election sentiment. JPMorgan projects the dollar could reach R$5.50 in a negative scenario, while a positive outcome could see it drop to R$4.90. The bank notes that the options market prices in about 6% implied volatility for the election event.
Citibank has shifted its carry trade strategy, replacing the real with the South African rand due to heightened election risk, despite Lula's strong lead. Goldman Sachs predicts increased volatility for the real, with its performance now more dependent on post-election fiscal policy expectations rather than current economic data, revising its dollar forecasts to R$5.20 in three months and R$5.10 in six months. Itaú BBA anticipates the dollar at R$5.30 by the end of 2026, citing a more challenging environment for the Brazilian currency, partly due to expected additional monetary tightening in the United States.
