Brazil's Stock Market Plummets and Real Devalues Sharply: Three Reasons Shaking the Market

The Brazilian financial market experienced one of its worst days of the year on Tuesday as the Ibovespa plummeted 2.5% to 167,874 points, marking its worst session in five months. Meanwhile, the dollar rose 0.98% to R$5.1608. The sharp correction reflected a combination of domestic issues that heightened the perception of risk regarding Brazilian assets.

Three main factors were behind the movement: pressure on interest rates, the electoral scenario, and the outflow of foreign capital, compounded by a less favorable international context due to tensions surrounding the Strait of Hormuz.

The first focus was on inflation and monetary policy. The National Consumer Price Index (IPCA) for July showed a year-on-year inflation slowdown to 4.44%, down from 4.64% in June, and returned to within the tolerance band of the Central Bank of Brazil (BCB).

However, the monthly figure was 0.07%, above the 0.03% expected by the market. The difference may seem small, but it gained relevance as it coincided with the publication of the minutes from the last meeting of the Monetary Policy Committee (Copom).

The BCB reduced the Selic Rate by 25 basis points last week to 14% annually, marking the fourth consecutive cut. However, the document released on Tuesday made it clear that the easing process does not imply a quick shift towards an expansive monetary policy.

The agency stated that inflation continues to be driven by demand and that rates must remain in restrictive territory to ensure convergence towards the 3% target. At the same time, it acknowledged that monetary policy is already affecting economic activity and that both general inflation and core measures have begun to decelerate.

This recalibration of expectations pressured future rate contracts and, by extension, stocks. With a Selic still at 14%, any signal that the rate-cutting cycle could be slower reduces the attractiveness of Brazilian equities.

Elections Begin to Factor into Prices

The second factor is political; a new poll published on Tuesday showed that President Lula da Silva continues to lead Flávio Bolsonaro in a potential runoff, but with a smaller margin.

The president would receive 48% against 39.1% for Bolsonaro. In June, the scenario was 49.3% to 36.8%, respectively. This means Lula's lead has decreased from 12.5 to 8.9 percentage points.

Indeed, the data confirms that the election is becoming more competitive, as investors try to anticipate what the fiscal policy of the next government will be.

In this sense, during the session, another relevant signal emerged: Bolsonaro's campaign is preparing a new fiscal rule that would tighten limits on public spending growth when debt reaches considered high levels. According to sources cited by Reuters, the scheme could even lead to a freeze on federal spending in real terms under certain scenarios.

The market, therefore, begins to incorporate different economic policy scenarios for 2027. The election is still far from being defined, and this uncertainty raises the risk premium of Brazilian assets.

Outflow of Foreign Capital and Increased Risk Aversion

During the session, there was also an outflow of foreign capital, and the Ibovespa lost more than 2.6%, while the main stocks in the index deepened their losses. Petrobras fell around 1.3%, Vale more than 2%, and Itaú 3.5% during the afternoon.

This was compounded by international factors. Brent oil ended the day up 1.36% at $88.91, amid uncertainty over a possible reopening of the Strait of Hormuz and the lack of an agreement between the U.S. and Iran. Wall Street also ended in negative territory.

For Brazil, higher oil prices have an ambiguous reading, as they benefit companies linked to crude production but can also fuel global inflationary pressures and complicate the rate reduction process.

The Combo That Hit the Real

The dollar reacted quickly to the stock market context of the neighboring country. After two consecutive days of gains, the U.S. currency ended at R$5.1608, appreciating 0.98%. The movement reflected the increase in domestic risk aversion following inflation data and new electoral polls.

The central point is that the market is not interpreting the July inflation data in isolation. Year-on-year inflation is indeed declining and has returned to the BCB's tolerance band, but the monthly figure was somewhat higher than expected, and long-term inflation expectations remain a concern for the Copom.