Brazil to complete Latin America's second pink tide?

Wells Fargo Research Team Wells Fargo

Summary

Latin America's return to the left-side of the political spectrum has been reminiscent of the original “pink tide” — the first time regional politics were dominated by left-leaning administrations in the 1990s and 2000s. But, the shift is not over yet as Brazil will host the first round of presidential elections this weekend, where former president Lula da Silva holds a wide lead over incumbent President Bolsonaro. Lula's rise concerned markets in 2002; however, his prior administrations, despite being highlighted by the initiation of social spending programs and wealth redistribution, were not especially radical and represented a fair degree of fiscal prudence. While Lula's party manifesto suggests a radical policy platform, we believe Lula will be more modest as he recently signaled technocratic policymakers will be part of his administration, and due to the fact Brazil's current public finance position requires tight fiscal policy.

In the event of a negative market reaction to a Lula victory, Brazilian real weakness should be faded. However, over the medium-term we believe the currency could weaken as external developments lead to U.S. dollar strength, and as Fed-Brazilian Central Bank monetary policy divergences build over time. We do not expect local political risk to be a source of Brazilian real depreciation, although we note that risks around our USD/BRL exchange rate forecasts are tilted toward a weaker Brazilian currency as country-risk premium could rise during Lula's third term. While not our base case scenario for the real, Lula still represents a potential risk to fiscal stability, and if credible fiscal policy evaporates, the Brazilian real could reach all-time lows against the U.S. dollar.

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Wells Fargo Research Team

Wells Fargo

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