Brazil’s upcoming presidential election is beginning to unsettle investors, with several asset managers reducing exposure to the Brazilian real and local bonds after a strong run for the country’s carry trade, according to a report by Bloomberg.
The Brazilian currency has gained roughly 6% against the US dollar this year, making it one of the stronger-performing emerging-market currencies. High domestic interest rates have been a key attraction, allowing investors to earn substantial carry by funding positions in lower-yielding currencies.
That appeal is now being tested as political uncertainty increases ahead of the October election.
VanEck portfolio managers David Austerweil and Eric Fine have reduced positions in Brazilian local fixed income, while Vontobel’s Thierry Larose has moved to an underweight position in the real. Aberdeen’s Kieran Curtis has also been cutting currency exposure.
For Curtis, the decision is less about predicting the election result than reducing vulnerability to a period of heightened volatility.
Brazilian President Luiz Inacio Lula da Silva currently leads opinion polls and is widely viewed as the favourite to secure another term. Betting markets put his chances at roughly two-thirds, although some surveys indicate the contest could be considerably closer.
The prospect of another Lula administration has revived concerns about Brazil’s fiscal trajectory, particularly whether the government will be willing or able to implement measures capable of stabilising public finances.
Those concerns have precedent. A sharp loss of investor confidence in late 2024 sent the real to a record low and triggered a broad selloff in Brazilian equities and both local- and hard-currency debt.
Recent polling has already produced a market reaction. A survey showing Lula with a larger-than-expected lead over Flavio Bolsonaro on Tuesday contributed to a decline in the real, which became the weakest performer among 31 major currencies tracked by Bloomberg.
The risks are being reflected in local hedge fund positioning. Ibiuna Investimentos has positioned for lower short-term rates but higher long-term borrowing costs, a stance that reflects concerns over the country’s fiscal outlook. Rio de Janeiro-based Adam Capital has meanwhile warned that real yields on inflation-linked government bonds have risen above 8%, describing that level as unsustainable.
The real remained under pressure the following day even as many other emerging-market currencies advanced.
Brazil’s bond market is showing signs of increasing investor caution as well. Yields have risen, while demand at weekly Treasury auctions has become less consistent. The currency and equity markets had remained comparatively resilient until recently, helped by a supportive global environment for emerging-market assets.
Hedging activity in the real remains relatively subdued compared with previous Brazilian election cycles, according to State Street. That leaves scope for investors to increase protection if political concerns intensify, potentially putting additional pressure on the currency.
