Several variables are changing simultaneously which are hurting the prospects for Brazilian assets. The main ones are: (A) Dilma is gaining ground and Marina losing momentum faster than we expected, (B) the broad strong dollar trend hitting EM across the board, and (C) a global equity sell off.
As new information about the presidential race comes in, we are adjusting our views in two ways. (1) We again consider the tail risk of Dilma winning in the first round, though we still think this is unlikely; (2) The chances of Marina winning are obviously smaller, though we continue to think she has a strong chance.
It is still unlikely that Dilma scores a first round victory in the elections next Sunday (October 5), but it appears that markets are pricing in some of this risk. Fair enough. The chances of this happening have certainly increased. For a first round victory to take place, Dilma would need more votes than all the other candidates combined.
Taking the latest poll (Datafolha), Dilma has 40% of voter intention in the first round, and would need to rise another 6 percentage points to win (or supporters of other candidates decide to vote blank). However, we also note that the more the risk of a first round victory by Dilma gets priced in, the larger the chance of a relief rally if it does not happen.
We change our view from “slightly better chance of a Marina victory” to “about even chances.” And if the current trend continues, Dilma could easily start the second round as the clear favourite once again. Our change in view is mainly due to the inability of Marina in articulating her views and the effectiveness of Dilma’s attacks against her.
Here is an update of the ever-changing factors to consider for the race:
* The impact of the negative campaigns against Marina had a fast and noticeable effect.
* The PT has a larger and more experienced propaganda machine.
* There is the risk that more voters switch from Aecio to Dilma (instead of Marina) than expected.
* As Marina enters the “normal” political electoral circuit, she starts to look more like a “normal” politician, hence losing some of the protest votes.
* The opposition has been unable to articulate an effective attack against Dilma, despite her many “open flanks” (corruption scandal, economy, desire for change, etc.).
* Marina will have equal television time to Dilma (currently Dilma has over 11 minutes and Marina has just 2). This matters, but it’s probably not a game changer on its own.
* A pragmatic alliance with the opposition party PSDB is still a significant possibility (though far from certain). While this will hurt Marina with some voters, it should be a net positive.
* In the second round, she will no longer be attacked by Aecio and the other candidates.
*The Petrobras corruption scandal continues to percolate and get closer to the Dilma. So far, this seems to have little impact but it could easily be exploited by Marina.
Although we were correct in calling for the BCB to step up its FX intervention, we were wrong in our call that USD/BRL would not hold above the 2.40 for long. This is in part due to the broad strong dollar trend and general risk aversion, but also to the larger deterioration in Marina’s advantage than we expected. At this point it is unclear to us what the central bank’s reaction function looks like. It is quite possible that the BCB has shifted its “comfort zone” to adjust to broad dollar-strengthening trend. So maybe USD/BRL 2.50 is the new top. We will only know this in time. It’s also worth noting that the Bovespa has now given up all of its post-Campos death gains.