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Brazil currency, markets slump as traders wait for Lula's economic plans

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Brazilian assets fell Monday as investors awaited more details on Luiz Inacio Lula da Silva’s plans for Latin America’s largest economy after he won the presidential runoff election.

The Brazilian real weakened as much as about 2% against the US dollar before trimming losses to 0.8% on Monday morning, local time. In US premarket trading, the $5.5 billion US-listed iShares MSCI Brazil ETF, the largest exchange-traded fund tracking Brazilian stocks, fell 2% and Petroleo Brasileiro SA’s US-traded shares slumped 6%.

Lula beat incumbent Jair Bolsonaro, marking a historic political comeback for the leftist who had led the country from 2003 to 2010. The winning margin – less than 2 percentage points – was the narrowest in the 40 years since Brazil returned to democracy. The president-elect will face a divided country and a divided congress, with Bolsonaro’s allies having captured a large presence in both chambers on top of controlling the country’s three most populous states, Sao Paulo, Minas Gerais and Rio de Janeiro.

“I would be cautious with volatility in state-owned enterprises,” said Malcolm Dorson, a portfolio manager at Mirae Asset Global Investments in New York. “If Lula surrounds himself with the right people and says the right things, the market could buy any initial dip and continue its year-to-date run.

The Lyxor MSCI Brazil UCITS ETF listed in Paris fell 4.7%. Brazil’s dollar bonds remained weaker after paring losses in European trading, with the yield on its note due 2031 up six basis points to 6.4%.

“The market does not like uncertainty and lack of visibility,” said Stephane Ekolo, a strategist at TFS Derivatives Ltd. in London. “And so far Lula hasn’t done anything to alleviate any of the two.”

Still, some investors are hopeful that the tight race — and comments in Lula’s victory speech about the dangers of a divided country — signaled that he may take a moderate approach to governing Latin America’s largest economy. While many money managers would have preferred the staunchly pro-business Bolsonaro, they’re hoping Lula can repeat the success of his first terms in office, when the currency and stocks soared on the back of robust economic growth driven by soaring commodity prices.

While a Lula victory was expected by markets, the impact will depend on Lula’s signals and whom he chose to replace Paulo Guedes as economy minister, according to RBC Capital Markets.

“It will be hard for Lula to stray too far from the multi-party and more centrist alliance he built for his campaign,” RBC Capital Markets’ Elsa Lignos wrote in a note.

The possibility of a contested election had also been keeping investors on edge. Many analysts cited the potential of a turbulent transition of power as one of the biggest risks in the aftermath of the vote. The incumbent had cast doubt on the election’s integrity in the run up to the vote.

Read more: These Are the Stocks to Watch as Lula Elected President

Lula’s victory should put education stocks in the spotlight given his support for a government program that provides cheap loans to students. Retailers that cater to low-income customers may also be active on prospects for more social aid that would boost consumer spending.

Shares in Sabesp, the water utility controlled by Sao Paulo state, may rally after Brazil’s former Infrastructure Minister Tarcisio de Freitas was elected governor Sunday. De Freitas, an ally of Bolsonaro, has previously suggested support for privatizing the company, and Bradesco BBI has said the stock could more than double if that comes to pass.

Money managers including Franklin Templeton and Robeco have been relatively optimistic about the outlook for Brazilian stocks no matter who won the presidency, figuring that the country was positioned better than peers, thanks in part to alluring valuations and high interest rates. Its markets have outperformed other developing-nations this year.

“Assuming that an orderly transition of power duly unfolds, the effect should be to lower the political risk premium on deeply undervalued Brazilian assets,” said Udith Sikand, a senior emerging-markets analyst at Gavekal Research, in a note.

Lula has said he’s aware he needs a “great” economic team to ensure investor confidence, though he didn’t give many specifics in his victory speech Sunday.

And there may be less of a threat of radical policies anyway. Centre-right parties had a strong showing in Congressional elections earlier this year, which analysts say will provide a check on the new president.

“The result is strong enough to support a relatively clean claim for Lula but not large enough to pull him to adopt a more left-leaning agenda,” said Daniel Tenengauzer, the head of market strategy at Bank of New York Mellon. “A Lula administration will likely need to be cognizant” of powerful centrist lawmakers who would go against radical economic changes, he said.

The main drivers for Brazilian assets will be the makeup of Lula’s economic team and clarity on his economic and fiscal proposals, according to Sarah Glendon, a senior analyst at Columbia Threadneedle Investments in New York.

“The market will want to know which Lula we are in fact getting as president of Brazil for the next four years,” she said.

– With assistance from Abhishek Vishnoi, Chester Yung and Colleen Goko.

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