Brazil’s markets sink to 2026 lows on fears over Lula’s policies - Valor International

Brazilian assets suffered another selloff on Tuesday (Nov. 3), ending the session at their weakest levels of 2026 as uncertainty over economic policy under President Luiz Inácio Lula da Silva's (Workers' Party, PT) fourth term continued to unsettle investors. The latest losses came a day before the Central Bank's monetary policy decision.

The exchange rate per U.S. dollar rose 0.79% to close at R$5.48, its highest level since late December. The benchmark Ibovespa stock index fell 1.42% to 165,529 points, its lowest close since January 16. The index has now lost 20.82% from its October highs, pushing it into bear market territory.

Much of the recent market debate has centered on a proposal by economist André Lara Resende, one of the architects of Brazil's Real Plan, to cut the benchmark Selic interest rate to 7.5% within 12 months. His argument is that the high cost of servicing public debt stems primarily from monetary policy rather than fiscal imbalances.

Several members of Lula's PT have publicly embraced the proposal in recent days, raising fears among investors that such an unorthodox experiment, if implemented, could trigger a sharp repricing of Brazilian assets while damaging institutional credibility and draining foreign exchange reserves.

Adding to the unease is the government's failure to signal a shift toward more centrist economic policies, either through potential appointments to the Finance Ministry or nominations to the Central Bank's board.

"Although we doubt the proposal will be implemented, the discussion suggests that the Lula government may be looking for ways to avoid the painful fiscal adjustment needed to stabilize markets," said William Jackson, chief emerging markets economist at Capital Economics. "That would call into question our baseline scenario of targeted austerity measures to improve the primary fiscal balance over the coming years and keep the risk of further financial market turmoil alive."

Jackson said implementing the proposal would likely stimulate demand through lower borrowing costs but also fuel inflation and weaken the real.

"The authorities would probably need to introduce capital controls because otherwise the low interest rate differentials would lead to prolonged capital flight," he said.

Camilo Cavalcanti, partner and portfolio manager at Oby Capital, said it is too early to determine whether the dollar has room to rise further against the real.

"While signals about the direction economic policy could take point to a weaker exchange rate, high interest rates are doing their job by making it expensive to bet against the real. That makes timing particularly important," Cavalcanti said.

Oby currently holds no directional positions in Brazilian markets, maintaining only relative-value trades along the interest rate curve.

Brazilian bond yields climbed sharply on Tuesday. The January 2029 interbank deposit (DI) futures rate rose to 15.13% from 14.96%, while the January 2031 contract jumped to 15.43% from 15.27%.

Another source of concern was a marked deterioration in inflation forecasts in the Central Bank's Focus survey, fueling speculation that policymakers may be forced to end their interest rate-cutting cycle at Wednesday's Monetary Policy Committee (Copom) meeting.

The median forecast for consumer inflation, as measured by the IPCA index, in 2027 jumped to 4.76% from 4.34%, while the projection for 2028 climbed to 4% from 3.75%.

Longer-term expectations also moved further away from the Central Bank's target. The median forecast for 2029 rose to 3.98% from 3.5%, while the 2030 estimate increased to 3.82% from 3.5%.

In equities, investors also grew concerned about the gap between Petrobras's domestic fuel prices and international benchmarks. The oil producer's preferred shares fell 3.79%.

Other major stocks suffered losses across the board. Mining giant Vale's preferred shares declined 2.85%, while Bradesco's common shares led the banking sector's losses, falling 2.02%.

A market participant who requested anonymity said fears of an unorthodox approach at the Finance Ministry, combined with reports about prospective Central Bank appointments and the possible isolation of the institution's chair, Gabriel Galípolo, contributed to Tuesday's negative sentiment.

The investor argued, however, that markets have yet to fully price in those risks.

"Prices still do not fully reflect concerns about a more unorthodox approach at the Finance Ministry and the Central Bank. For now, they are merely flashing a warning signal," the person said.

With Lula set to appoint six Central Bank directors by the end of 2027, investors fear he could reshape the institution's traditionally technical leadership and make it less forceful in fighting inflation.

Fernando Siqueira, head of research at Eleven Financial Research, said Lara Resende's proposal to lower interest rates as a way to reduce the fiscal deficit has drawn comparisons with Turkey. There, politically driven rate cuts beginning in 2021 were accompanied by soaring inflation and a sharp currency depreciation before the policy was eventually reversed.

"This issue will likely continue to influence markets and dominate the news in the coming days," Siqueira wrote on LinkedIn.

"Looking at what happened in Turkey, I would not be surprised to see the real depreciate and inflation expectations priced into financial markets rise over the next few days."

This article was translated from Valor Econômico using an artificial intelligence tool under the supervision of the Valor International editorial team to ensure accuracy, clarity, and adherence to our editorial standards. Read our Editorial Principles.