Brazil’s Dicey Politics Have Traders Piling Into Election HedgesBy , , and
Implied volatility for vote period picked up in past month
Early polls show strong support for populist candidate
Brazilians may be a year away from voting for their next president, but investors are already plenty worried.
Measures of implied volatility for the currency show traders pricing in big swings around the October 2018 vote, even as calm pervades in the near term. The split has taken the ratio between one-year and six-month implied volatility to the highest since early 2014.
Investors are nervous that the country’s next leader will have a populist bent and won’t prioritize the economy and shoring up finances, key themes for the business community after years of political turmoil derailed growth and sent bond and stock markets on a wild ride. Early polls show the most support for former President Luiz Inacio Lula da Silva, who is in the midst of fighting corruption charges, followed by far-right congressman Jair Bolsonaro, best known for his rants against homosexuality and a firm law-and-order stance.
“Brazilian assets will be very volatile ahead of the next ballot,” said Mauricio Oreng, a senior strategist at Rabobank in Sao Paulo and one of the most accurate forecasters in the past quarter. He sees the real at 3.2 per dollar at the end of December and 3.4 per dollar at the end of 2018.
The two potential candidates most favored by investors, Sao Paulo Mayor Joao Doria and state Governor Geraldo Alckmin, trailed a distant third and fifth place in the most recent voter poll. Still, the list of contestants is far from closed -- parties haven’t chosen their nominees yet -- and it’s possible that Lula won’t be allowed to run as the corruption probe heats up. A survey published by a local magazine Oct. 1 showed no clear front runner if Lula is barred.
"The most probable scenario is more fragmentation, and that makes markets more uncertain," said Carlos Kawall, the chief economist at Banco Safra SA in Sao Paulo and a former federal treasury secretary.
While a globalist, free-market approach to government has recently taken hold in neighbors such as Argentina and Peru, Brazil has teetered back and forth between populist movements and market orthodoxy.
After President Dilma Rousseff’s policies swelled the deficit and cost Brazil its investment-grade credit rating in 2015, the real tumbled to a record low. The currency reversed course in 2016, when Rousseff was impeached and replaced by Michel Temer, rallying 22 percent for the world’s biggest gain as he pursued a series of unpopular austerity measures aimed at shoring up the budget. Those policies have made Temer deeply unpopular with most Brazilians, and he is unlikely to be a candidate next year.
“Should the government be perceived as less likely to move forward with fiscal reform, it could create a more challenging environment for the BRL and would likely restrain the currency,” said Eric Viloria, a strategist at Wells Fargo Securities and one of the top forecasters for the real, according to Bloomberg rankings.
While politics are driving the hedging strategies that are pushing up implied volatility, most forecasters see relative calm for the real through the end of next year. The currency will weaken slightly to 3.15 per dollar by the end of December and drop to 3.4 by the end of 2018, according to the median estimate of analysts surveyed by Bloomberg. The real gained 0.3 percent to 3.1341 per dollar as of 10:24 a.m. in New York.
If polls continue to show strong support for candidates out of favor with investors, the real could return to levels last seen in early 2016, according to Juliano Ferreira, a strategist at BGC Liquidez brokerage in Sao Paulo, who says this isn’t his base-case scenario.
“Markets currently price in a reasonable chance of a center-right candidate getting elected,” he said. “If this doesn’t happen, the real could return to the 4-per-dollar level.”
— With assistance by Carlos Torres