Brazilian markets could quickly spiral into crisis mode amid 'devilish' election choice

  • Brazil is set to hold a two-round ballot next month, with the vote widely expected to be the most unpredictable since the country's return to democracy three decades ago.
  • "Whoever wins will preside over a polarized nation, with almost half the electorate viewing the new president negatively… The near-term outlook for Latin America's biggest economy isn't great," Cliff Kupchan, chairman of Eurasia Group, said in a research note published Tuesday.
  • Brazil's real is down 18 percent year-to-date versus the greenback.
Opponents of former Brazilian President Luiz Inacio Lula da Silva demonstrate in the city of Curitiba on March 28, 2018.
Heuler Andrey | AFP | Getty Images
Opponents of former Brazilian President Luiz Inacio Lula da Silva demonstrate in the city of Curitiba on March 28, 2018.

An upcoming presidential election in Latin America's biggest economy has the spill-over potential to dramatically impact emerging markets, strategists told CNBC this week.

Brazil is set to hold a two-round ballot next month, with the vote widely expected to be the most unpredictable since the country's return to democracy three decades ago. Political corruption investigations have dominated the headlines ahead of the election, as voters become increasingly alienated with several of their representatives.

Meanwhile, emerging market currencies in general have suffered in recent weeks, as escalating trade tensions threaten to curb global economic growth. The MSCI emerging markets stock index is down nearly 12 percent since the start of the year.

"The evident economic difficulties that have hit Turkey and Argentina this year have so far been viewed by markets as largely confined to those two countries — with limited spill-over potential to other emerging markets," Jon Harrison, managing director of emerging-market macro strategy at TS Lombard, told CNBC via email.

"What has changed is Brazil. The likelihood of a market friendly outcome in the Brazilian election first-round has receded (and that) has the potential to shock markets out of their complacency," he added.

Bolsonaro vs. Haddad

Brazil's far-right candidate Jair Bolsonaro currently leads in first-round voting, according to a poll published Wednesday by the Brazilian Institute of Public Opinion and Statistics (Ibope). However, the former military officer is projected to lose to most of his political rivals in a likely run-off ballot.

Bolsonaro is estimated to receive around 22 percent of the vote in the first-round on October 7, with environmentalist Marina Silva and leftist Ciro Gomes both tied for second on 12 percent.

The Ibope survey of slightly more than 2,000 voters is the first official poll to be released since a Brazilian court ruled jailed leftist Luiz Inacio Lula da Silva would not be eligible to run for office.

Brazilian right-wing presidential candidate Jair Bolsonaro speaks to supporters during a campaign rally in the district of Ceilandia.
EVARISTO SA | AFP | Getty Images
Brazilian right-wing presidential candidate Jair Bolsonaro speaks to supporters during a campaign rally in the district of Ceilandia.

Analysts expect Lula to be replaced by far-left candidate Fernando Haddad, who is seen campaigning on an unfriendly platform for investors.

"A second-round contest between far-right Bolsonara and far-left Haddad would be a shock to investors, markets would react badly to the prospect that essential fiscal reforms would not be on the agenda of either candidate," Harrison said.

"In this event, assuming that the candidates do not manage to reassure investors, Brazilian markets could quickly deteriorate to crisis conditions," he added.

Near-term outlook 'is not great'

The Ibope poll has Bolsonaro and Haddad running practically neck-and-neck in a second round run-off vote.

"Brazilian markets have woken up to this devilish choice, and the real has appropriately plummeted," Cliff Kupchan, chairman of Eurasia Group, a Washington-based political consulting firm, said in a research note published Tuesday.

"Whoever wins will preside over a polarized nation, with almost half the electorate viewing the new president negatively… The near-term outlook for Latin America's biggest economy isn't great," he added.

The Brazilian real stood at 4.14 against the dollar Thursday afternoon, after falling beyond 4 per dollar for the first time since February 2016 late last month. Brazil's currency is down 18 percent year-to-date versus the greenback.

Analysts at UBS expect the real to pare its recent losses over the coming months, trading at around 3.7 by the start of 2019.