Currency Traders Know They’ve Got An Awful Lot Of Caprice In Brazil: The Geopolitical — Stock Market Connection

In a year of awful events Brazil gleamed for a few hours with what investors can only view as the best possible outcome in the Presidential election. Lula’s narrow win bodes well for fiscal and monetary policy and would normally buoy the Brazilian real, but hyper-Trumpist Jair Bolsonaro has not only failed to concede defeat but tacitly encouraged his supporters to disrupt the economy. A quick resolution to the conflict would be one more reason to buy into the global equity rally that has emerged despite a raft of bad news. The volatility risk premium points to a higher market over the next few days, but my technical reading of key stocks in the S&P 500 is near-term bullish and longer-term bearish. Yesterday's cross-asset action brought one positive factor for US stocks. The US yield curve is falling and in the current context that is bullish. Expect the S&P 500 to rise modestly over the next few days before coming back to earth as we approach the midterms.

The market’s pleasure in Lula’s narrow victory rests on the notion that he has little mandate to implement far-left programs and will govern with more sense than Bolsonaro. But as an ideologue with a history of corruption Lula has every emotional incentive to go the way of Liz Truss and aim for maximum fiscal policy, and without the growth ideology to lend it substance. His previous terms featured large spending programs aimed at redistribution and his instincts are to rein in the capitalist economy in favor of the public sector. And as someone who suffered prison at the hands of the Brazilian center-right, he could well be geared to exact revenge rather than act as a statesman.

But in the current era of bond vigilantism, for Lula to even float a substantive redistributionist agenda risks felling the Brazilian Real and damaging global economic confidence. Just as Truss suffered the wrath of bond vigilantes this Autumn, and Turkey has suffered for over a year and Argentina since 2020, so too would Brazil if it veers from economic norms. And as the 12th largest economy in the world and a major commodities exporter, an economic shock to Brazil would have effects similar to the Russian shock of this year.

Lombard Odier notes “Luiz Inacio Lula da Silva has won Brazil’s presidential vote, promising state investments, tax reforms and to end hunger with a programme that depends on forging allies in a polarised Congress. He has already said that he will name Geraldo Alckmin, a former governor of Sao Paulo, considered sympathetic to business and markets, as his vice-president. Elections on 2 October for the Chamber of Deputies and Senate produced an even more polarised, right-leaning Congress with more seats for Bolsonaro’s allies, making it difficult for Lula to enact his agenda. Lula will have to draw support from the influential centrist block to fend-off any impeachment proceedings and pass laws. Despite a punitively high interest rate of 13.75% since August, around 6% in real terms, Brazil is set to enjoy a second consecutive year of above 2% growth in 2022 thanks to the global commodities boom and solid consumption buoyed by welfare payments. The tone will be different in 2023. With the negative impact of high real rates filtering into the economy and global demand slowing for raw materials, Brazil will likely see its growth rate fall below 1% in 2023. Lula has pledged to tackle housing, improve public infrastructure, reform taxes and end hunger, in a country where the United Nations estimate more than a quarter of the population lacks enough to eat. With spending set to increase after the election and lower commodity revenues, the fiscal surplus may begin to fade. Consequently, we see public debt-to-GDP, which reached nearly 99% in 2020, bottoming out in 2022 before gradually rising from 2023. The International Monetary Fund has recently echoed this outlook by projecting a rebound in debt-to-GDP ratio in the coming years (see chart). Our expectation is that centrist parties in Congress will constrain Lula’s fiscal policy, so that he will not be able to push for wholesale changes in the spending cap or the tax system.”

I see Lula has craftily governing from the center in the first year while stoking progressive social values in order to rally his supporters and cut into the Bolsonaro voting bloc that contains significant numbers of pro-capitalist liberals. Should Lula become a Brazilian Bill Clinton the global economy will gain ballast as the scourge of both far-leftist and reactionary right-wing politics abates, setting up for a resumption of the bull market sometime in 2023,

Yesterday and again this morning I added positions in the levered ETF UPRO and effectively neutralized my short position in the S&P 500. Consequently my current positions include a small cash position, Goldman Sachs (GS), 3M (MMM), Pfizer (PFE), Starbucks (SBUX), and the ETFs UPRO and SPXU, all of which nets out to a small long position in equities, which I expect to exit in the coming days.