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Wide-Open Brazil Presidential Race to Drag on Real

Brazil’s real, the world’s worst-performing major currency since February, is likely to suffer more losses in the run up to next year’s presidential election as a wave of recent street protests and a weak economy throw the race wide open, JPMorgan Chase & Co. said.

The tightening of the race in electoral polls, which until March showed President Dilma Rousseff winning in the first round, has become the main driver of investor sentiment and government policy, JPMorgan said. Reflecting the uncertainty, the bank cut its forecast for the real, which it now expects will weaken this year to 2.35 per dollar, compared with an earlier estimate of 2.25, and decline to 2.45 in the run-up to the October 2014 vote.

Brazil’s financial markets have proven volatile before previous elections, with the real plunging 38 percent ahead of Luiz Inacio Lula da Silva’s 2002 victory. When Rousseff disputed her first-ever election in 2010, buoyed by the economy’s fastest expansion in two decades, the markets remained calm. The June protests sparked by bus fare increases, combined with frustration over lackluster growth and rising inflation, may indicate the country is ready for change after a decade of Workers’ Party rule, JPMorgan said.

“The tide has turned,” JPMorgan analysts including Fabio Akira and Emy Shayo Cherman wrote in the Aug. 13 report. “Economic malaise could ignite a call for change, giving an important edge to the opposition.”

Policy Mix

While the race is too competitive to predict a winner, none of the likely candidates represent a radical alternative to the current policy mix, JPMorgan said.

Whoever wins will have to implement a “costly” adjustment to lower inflation and boost investor confidence by better controlling spending and opening the economy to more private investment, the bank said.

Approval of Rousseff’s government plunged by half in the wake of the protests and rebounded six percentage points to 36 percent in a Aug. 7-9 poll by Sao Paulo-based Datafolha. The nationwide poll had a margin of error of 2 percentage points.

Rousseff was favored to win 35 percent of the vote in the first round, compared with 26 percent for her nearest challenger, former Environment Minister Marina Silva, the poll found. Two other possible candidates, Senator Aecio Neves of the opposition Social Democracy Party and Governor Eduardo Campos, a government ally, trailed with 13 percent and 8 percent respectively. To win in the first round, a candidate needs more than 50 percent of valid votes.

Falling Real

The real has fallen 13 percent against the dollar in the past three months, more than any other major currency tracked by Bloomberg, with investors shunning emerging markets as the U.S. economy strengthens and the Federal Reserve signals it may scale back its $85 billion a month bond-purchasing program.

The currency weakness is complicating policy makers’ efforts to control inflation, which has been hovering near the 6.5 percent upper limit of the target range, without damping growth.

Latin America’s largest economy expanded just 0.9 percent last year, and analysts surveyed by the central bank have been cutting their forecasts for growth this year and 2014 since the June protests. Gross domestic product will expand 2.21 percent this year, according to the latest survey.

The unemployment rate is the election’s “wild card,” JPMorgan said. After dipping to a record low of 4.6 percent last December, the rate rose to 6 percent in June for the first time in more than a year.

Any further softening of the job market could further hamper Rousseff’s chances, triggering populist measures on the eve of the vote that would add to inflation concerns, the bank said.

“What until a couple of months ago was expected to be a relatively uncompetitive contest, is now a wide-open battle field,” the bank said. “Politics is slowly becoming the most important domestic variable in the market outlook.”

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