Brazil’s Markets and Politics Are Intertwined. Trump Is Key.

Outside court in Brazil during the trial of Jair Bolsonaro, the country’s former president, who is charged with plotting a coup following his 2022 election defeat. (Arthur Menescal/Bloomberg)

Brazilian assets are having a great year, after a calamitous second half of 2024. The iShares MSCI Brazil exchange-traded fund has jumped 30% since Jan. 1. The real is up 15% against the dollar. What happens next depends on two famously volatile politicians, Jair Bolsonaro and Donald Trump.

Bolsonaro, Brazil’s ex-president, went on trial before the supreme court Sept. 2 for allegedly masterminding an assault aimed at overturning his election loss in 2022. Investors assume he will be convicted by the court’s Sept. 12 deadline. Suspense swirls around who Bolsonaro will tap to run in his place next year.

Markets hope he will pass the baton to São Paulo state Gov. Tarcisio de Freitas, a pragmatically inclined 50-year-old who earned high marks as Bolsonaro’s infrastructure minister as well as in his current post.

“Freitas is a dream candidate,” says Verena Wachnitz, a portfolio manager for Latin American equities at T. Rowe Price.

The governor lately bolstered his chances by promising that pardoning Bolsonaro would be his “first official act” as president. Still, investors fear Bolsonaro could tap his wife or one of his sons instead. That would boost the increasingly certain re-election bid of 79-year-old left-leaning incumbent Luiz Inácio Lula da Silva.

“Lula is posting videos of himself running up the ramp at the presidential palace,” notes Elizabeth Johnson, head of Brazil research at TS Lombard.

President Trump’s July attempt to stop Bolsonaro’s trial—or “witch hunt,” as he called it—with a 50% tariff on Brazilian imports backfired. Markets shrugged it off, as Brazil exports more than twice as much to China as to the U.S., and Lula rose in the polls.

The U.S. president may have more potent weapons in his arsenal, though, fears Thierry Larose, portfolio manager for emerging markets local debt at Vontobel Asset Management: constraining U.S. investment into Brazil, for instance, or Brazilian banks that continue to do business with the sanctioned justices might face penalties.

“Escalation on the financial side could be quite negative for markets,” he says. “We have shifted from overweight Brazil to market weight.”

Equity investors may have to wait awhile for Brazil’s political dust to settle. The election is slated for next October. Candidates have until April 1 to commit themselves by resigning from their current posts.

Fixed-income players are “getting paid to wait,” though, argues Jae Lee, portfolio co-manager for local currency emerging markets debt at TCW. Brazil’s central bank, mindful of past inflation, is holding its key interest rate at 15% annually despite current inflation near 5%, yielding a world-beating “real interest rate.”

The monetary outlook, unlike the political one, is stable, with markets expecting gradual rate cuts starting next year.

“Any dips in Brazil’s currency will likely be a buying opportunity,” Lee says.

Changing the fiscal dynamics that have made Brazil one of the most indebted emerging markets will challenge any president. Essential reforms would include de-indexing health and education spending, the minimum wage, and pensions, not to mention pruning tax breaks for special interests, TS Lombard’s Johnson says.

But vibes matter in a congenitally volatile market. Expectations of a more fiscally hawkish government could move the central bank to loosen more quickly, T. Rowe’s Wachnitz says. With some 30% of government revenue allocated to debt service, falling rates would shrink the deficit as well as juicing the economy, a classic virtuous circle.

“Brazil needs a confidence shock,” she concludes.

Two men hold the keys to it.