The Ibovespa rose 10% in October and the real appreciated 4.5%, betting on a Flávio Bolsonaro victory. Lula won, with 51.8%. We expect that premium to be given back in the coming sessions, and Argentina, with country risk at 707 bps, arrives with no cushion to absorb the contagion.
The Flávio premium: what the Brazilian market had priced in before the runoff. October's moves in Brazilian assets summarize the market's bet. After the first round on the 4th, in which Flávio Bolsonaro obtained 47.0% against 45.2% for Lula da Silva, the Ibovespa went from 192,115 to 206,912 points in one session and the real appreciated from 5.21 to 4.99 per dollar. In the week of the 19th to the 23rd the index moved sideways (-0.2%, to 205,083) and the real closed at 4.98: the market added no further bets, but did not undo them either. Polls gave Flávio 51% to 49%, and prediction markets assigned him close to 80% probability that same Sunday.
Lula won, with 51.76% against 48.24% and 99.8% of ballots counted. It was not the result the market expected, nor the one it had priced in. The first signal came that same night: the EWZ, which tracks Brazilian equities in dollars, fell 18.5% in the after-market. It is a low-liquidity reference that probably exaggerates the adjustment, but the direction is unmistakable. Our thesis is that we will see a correction that returns a good part of the premium built up since the first round, and that Argentina, which did not capitalize on the regional relief over the last two weeks, can nonetheless suffer its reversal.
International outlook: Brazil reprices and the world does not help. From electoral premium to fiscal premium. The rally was pricing not just a change of name, but a change of fiscal regime. Gross debt reached 82.9% of GDP in August (71.7% at the end of 2022), the primary deficit returned to 0.6% of GDP and interest payments hover around 8.9% of GDP. With Lula, the expectation of a new spending ceiling fades and the 2023 rule remains in force, allowing real spending growth of up to 2.5% a year. Before the runoff, 80% of investors surveyed by Citi expected an Ibovespa drop of more than 5% in this scenario, and Bloomberg Economics expected a real up to 11% weaker.
In our view, the reasonable reference for the correction is the zone prior to the first round (Ibovespa near 190,000 points and the real around 5.20), with a risk of overshooting in the first sessions if an early fiscal signal does not arrive. One nuance limits the negative scenario: the elected Congress has a right-wing majority in both chambers (276 of 513 deputies, with the PL as the largest party), which constrains an agenda of spending expansion. The flip side is a Copom that on November 3-4 will have to decide whether to keep cutting the Selic from 13.75% with a weaker currency.
The impact on Argentina operates through three channels. Trade: Brazil is the main destination for industrial exports, and a weaker real penalizes sectors such as automotive. Financial: the first round had compressed country risk by 82 bps in two sessions, and the reversal of that regional premium now operates on a spread at the year's high. Sectoral: companies with exposure to Brazil and banks, which led Friday's rebound, are the assets with the highest beta to the correction.
Oil and rates: a floor that does not give way. Brent closed at USD 116.7 and WTI near USD 104, highs since May, on Houthi attacks against Saudi targets and higher transport costs. The 10-year Treasury yield fell from 5.08% to 5.00%, but not because of better inflation: on Thursday the Nasdaq fell 2.6% on doubts about the financing of AI investment, and gold lost 4% on the week, a pattern more typical of liquidity-driven selling than of a search for safety. With a composite PMI of 57.6, inflation expectations of 4.7% and a fiscal deficit of 6.2% of GDP, the pause priced in for October 28 does not imply relief: the market continues to expect hikes from December. For Argentina, the base rate will not provide the compression that the spread cannot achieve on its own; oil, however, supports the energy surplus.
Argentine outlook: country risk trades without a regional safety net. Country risk rose from 648 to 707 bps, after touching 717 on Friday, the 2026 high, and dollar bonds fell around 2%. It is the second week in which the spread has widened while the Treasury yield falls: the decoupling we flagged last week deepened. By contrast, the Merval rose 2.3% in pesos, with a 4.4% rebound on Friday led by banks. We read in equities a reaction to depressed valuations, while credit continues to price the 2027 dollar financing.
The week's data reinforce that mixed diagnosis. Externally, good news: September's trade balance showed a surplus of USD 2,976 million, a record for the month, with exports up 23.5% y/y and an energy balance of USD 1.6 billion; the BCRA bought more than USD 1.25 billion in October and gross reserves exceed USD 50 billion. Domestically, activity confirmed the recession: August's EMAE rose just 0.1% m/m after falling 2.8% in July and declined 1.7% y/y. Even with a rebound in September, we estimate a GDP drop of close to 2% q/q in the third quarter.
Abundant dollars and falling activity is the combination that country risk cannot quite resolve: the BCRA accumulates reserves, but activity reduces the political and fiscal margin heading into 2027, and that is what the market charges for in the long tenors. The wholesale exchange rate closed at $1,529.5, the year's high but with the band ceiling 27% above, with a gap to the contado con liquidación of close to 8% and the TAMAR stable, slightly above 24%.
Outlook: correction in Brazil, test for Argentina. What changed. The runoff eliminated the scenario that had sustained regional sentiment since early October. What did not change is the base rate, near 5%, nor the local diagnosis: rising reserves, an external surplus and a slow economy with the 2027 dollar financing still undefined.
What we expect. Corrections in Brazilian assets in the coming sessions: a weaker real, rising long-term rates and an Ibovespa that gives back part of October's gain, by a magnitude that will depend on Lula's first fiscal signal and on the Copom. For Argentina, country risk with no room to return below 650 bps in the short term and with a risk of new highs through contagion. We maintain our preference for short tenors on the dollar curve and a defensive position in Brazil-exposed assets; in pesos, the carry remains defensible with the BCRA buying and the exchange rate far from the band ceiling.
Risks. On the upside: an explicit fiscal commitment from the Brazilian government that limits the correction, a drop in oil and an official definition of the source of the 2027 dollars. On the downside: a disorderly adjustment of the real that halts the Copom's cuts, a Fed that brings forward the December hike, and a new wave of risk aversion tied to AI financing.
What to monitor. Monday the 26th's open in São Paulo, especially the real and the DI curve; the Fed on the 28th; US third-quarter GDP; the Copom on November 3-4; and in Argentina, the end-of-month Treasury auction and the pace of BCRA purchases. If the Brazilian correction is limited to returning the electoral premium, the contagion will be contained. If it turns into a crisis of fiscal confidence, Argentina will face a more demanding regional market just when it needs to secure its dollars.
