Brazil's real faced a sharp selloff after President Lula's unexpected reelection, with a CME currency futures contract trading 10% to 11% lower, an ING currency strategist said before markets opened.
Investors had bought the currency in anticipation of a right-wing government that would cut public spending and build closer ties with the Trump administration. The result put those bets at risk.
Speaking on Reuters' Market Talk, published Oct. 26, the strategist expected both the currency and Brazilian equities to fall when local trading began. Equity futures also pointed to losses.
“These are very big adjustments,” the strategist said. The currency's performance after the market opened would show how far investors would unwind positions built after the opposition's unexpectedly strong first-round result.
The next questions were whether Lula's opponent would accept defeat and whether a prolonged legal dispute would follow. Beyond the election result, investors would watch whether Lula followed through on promises to loosen government spending policy.
Such a policy would tend to weaken the currency, the strategist said. The remarks left open both the opposition's response and the spending decisions Lula would make.
Turning to France, the strategist rejected the idea that concern about the government's finances had reached an emergency. Political uncertainty over how parties would address the budget ahead of elections remained a concern.
Energy prices also affect the gap between French and German government bond yields, a measure of the extra return investors demand to hold French debt. Higher energy prices can widen that gap.
Falling oil prices could therefore narrow it even if budget concerns persisted. Social unrest also weighed on French bonds, while the euro had become less responsive to those concerns.
“For now we're not really seeing huge downside risk for the euro,” the strategist said, while expecting little relief for French government bonds.
If the European Central Bank became more concerned about France, its first response could be to curb expectations for future interest-rate increases. Buying French bonds would come further down the list of possible responses.
Elevated energy prices, however, kept policymakers concerned that higher costs would spread to other goods and services. The strategist expected the central bank to keep a December rate increase under consideration.
Wider French bond yield gaps combined with easing inflation by December could lead the central bank to signal less need for higher rates. Neither condition was presented as certain.
In the United States, weakness in artificial intelligence stocks had encouraged expectations of fewer Federal Reserve rate increases. Falling shares could reduce spending by wealthier households whose consumption had benefited from stock market gains.
The strategist described the stock market jitters as contained and did not expect a large dollar decline. The Fed would probably maintain its focus on inflation and support market expectations for a December rate increase.
