The Brazilian presidential elections are happening and the question that arises for us is: how does this affect the #coffeemarket?
In this article, we offer you a perspective on what to expect from Brazil’s political economic scenario. We outline the present situation, provide an outlook on what can potentially happen from now and how various developments might affect coffee prices and markets in general.
Background
For those unfamiliar, Brazil uses a 2-round voting system. This means that for the presidential election, there are usually two rounds of voting before anyone is elected. The first round (completed last Sunday) contains a wide array of candidates, however, if no candidate receives more than 50% in this round, then a second round will be conducted with only the two leading candidates.
This year, the first round was a close race between #Bolsonaro (right wing) and #Lula (left wing). Lula received a larger percentage of votes than the incumbent Bolsonaro, but because this is a 2 round vote, this is not necessarily predictive of the final outcome.
The country now waits for the second round, set to happen in Oct 30th and we have already started seeing the effects of this presidential election impact the coffee market.
We will return to the elections in a moment, but first let’s take a moment to understand exactly how this will affect coffee.
Brazil is the world's largest producer of coffee and so their currency has an outsized impact on the #coffee market.
In fact, Brazil’s currency (the BRL) is one of the main macroeconomic drivers for coffee prices. It is used by Brazilian producers, cooperatives and companies to trade their coffee. In short, these major sellers of coffee think of coffee prices in terms of #BRL.
This means that high coffee prices in BRL terms (weak BRL vs #USD) tend to incentivize selling, since producers are better paid, adding to the supply side. Low coffee prices in BRL terms (strong BRL vs USD), however, tend to discourage selling.
The Coffee Market is aware of this relationship and therefore it interprets BRL movement accordingly, even if there are no immediate and perceptible changes in liquidity.
We therefore have a direct correlation between the BRL and #KC.
Overview
Summarizing the entire situation, the elections are not expected to be the ultimate decider for the BRL’s direction, but rather, short-term noise that will heavily influence the next 30 to 40 days. Looking at the long-term, no matter which candidate wins, the market's attention will eventually focus on the risky fiscal scenario over the coming months, which is negative for investors and consequently for the Real.
This long-term effect on the currency may be more pronounced in case Lula wins, and we will be looking at this in detail a little further along in this article.
In summary, a great portion of the BRL’s volatility will be (at least partially) translated into an already volatile coffee market in this window of time.
How the 1st Round Election Affects Coffee
Bolsonaro received 43% to Lula’s 48%, but with record numbers of people abstaining from this initial vote. Prior to voting day, surveys were consistently projecting a 30% to 35% vote intentions to Bolsonaro. Therefore, the current president outperformed expectations and at the same time, a majority of conservative Senate and Congress seats were won in this first round.
Generally speaking, the Bolsonaro government is considered favorable for BRL strength while Lula is considered bearish for BRL strength. Because of this, Bolsonaro’s better than expected performance cheered Brazilian markets on Monday, producing the largest 1-day BRL rally in over a year.
Also, the major win of Bolsonaro’s allies in the Senate and Congress added to the mentioned rally: the interpretation here is that even if Lula wins, he won't have ample freedom to govern without limitations.
Bolsonaro’s strong performance vs consensus added a macroeconomic bullish influence over the coffee futures market, which resumed its rally on this large FX movement, after 3 days of consecutive losses.
KC has a lot of things going on besides, the Brazil elections though. Coffee was heading towards another confrontation against the 214c psychological support and the cert stocks are approaching critical levels. The BRL’s movement from 5.40 to 5.16 in only a session served as additional reason to coffee reversing direction in face of this support.
Perspectives for the 2nd round
The conclusion so far is that the race is “neck and neck”. Lula has a slight advantage, although a 5% difference in the first round is not decisive. Curiously, we have now a historical impasse that will soon be resolved: in Brazil, candidates who win the first round tend to win the second (advantage for Lula). However, historically speaking, candidates for re-election usually win (advantage for Bolsonaro).
To get a better view, let’s look at the numbers of the first round:
Lula (the favorite so far), received 57.2m votes (48.4%) and Bolsonaro received 51.1m (42.3%), while the other candidates (the “third way”), received 9.8m votes together (8.4%). According to the TSE (Superior Electoral Court), over 31m voters did not vote. In fact, the abstention rate has grown since 2006, when former President Luiz Inácio Lula da Silva (PT) was re-elected.
Some local political pundits are claiming that Bolsonaro and Lula need to win the votes from the third way in order to come out victorious. Their thesis is that the second round will be defined by the transfer of votes from the center (9.8m total), and I think that’s valid. This may be true, but there is a “catch” here to consider.
Considering the numbers we have in hand, mobilization will also be key. The candidate best able to mobilize the more than 31 million Brazilians who did not go to vote in Oct 2nd would have a massive advantage to win.
That said, the track record shows that people who abstain in the first round tend to not vote in the second. Therefore, there is a possibility that this share of votes (31m) may not be as decisive as it could be and that the votes from the center could be the decisive factor in a final decision.
During this month, both candidates will continue to form alliances with governors and former opponents to increase influence for the second round. The state of Minas Gerais has a decisive electoral volume, which is so far pending towards Lula.
This week, Bolsonaro formed an alliance with the re-elected MG governor (Romeu Zema), which now supports the maintenance of the current president. This may or may not help Bolsonaro turn the game in Minas Gerais, but it surely increases his chances of gaining an advantage in this important state. Conservative senators and governors elected are also working for the re-election of the president but that's no guarantee of victory.
Playing in Lula's favor are the support of the defeated candidates Simone Tebet and Ciro Gomes, who together mobilized 8.5m of votes in the first round. This is a major support for Lula. However, given the virulence of Ciro’s (3.6m votes) campaign against Lula, it is not absurd to infer that some of his enthusiasts have migrated to Bolsonaro.
Altogether, I see a slight advantage to Lula, despite the tight margin against his rival. If he manages to convert only 20% of the (1st round) third way votes, he will have a total of 59.21m votes while Bolsonaro would have 58.8m. Considering Lula has firmed support with the third way, odds for this scenario are strong, but we still have an unknown variable in the 31m abstentions.
Another number that works in Lula’s favor is his investments in the campaign, which are more than double the amount of the money invested by Bolsonaro.
To get a second opinion, we conducted some informal polling with friends from Brazil who work in the financial markets. The feedback hung around 60/40 odds in Lula’s favor.
However, we can’t be too certain of the outcome.
Both candidates are forming alliances and adjusting their strategies. There are still debates to happen and the candidates remain relatively close in percentage numbers.
Anticipating effects for the Coffee Market
Base scenario 1 – Bolsonaro wins (~40% chance)
Considering a base scenario in which Bolsonaro wins, this means the maintenance of a government that has clear / known proposals, although still being a risk to the spending ceiling and therefore the fiscal scenario.
This makes investors more comfortable with Brazil and more likely to take positions in the country. Therefore, the BRL could gain (bullish KC) across this month if market perceives odds of his victory increasing. If Bolsonaro comes up victorious, the Brazilian currency may influence coffee prices positively.
Base scenario 2 – Lula wins (~60% chance)
Lula campaigned on his past reputation as a president. If he wins, we don't know who's going to be the next finance minister, nor what will be his approach towards the spending ceiling. We also do not know what kind of tax reform he will pursue, nor whether he will try to pass administrative reform.
In summary, there are a lot of unanswered questions regarding his potential government. This means increased risk perception in case the PT candidate wins and a potential flow of investments outside Brazil, which could then cause a large BRL selloff. The consequence for our coffee market here would be an extra push for upward impulses.
Final Considerations and Conclusion
Altogether, we see potential for increased volatility in the Brazilian FX market this month. The elections take place Oct 30th, so the oscillations are more likely to concentrate at the end of the month and the beginning of November. This should add an extra share of influence from the BRL to KC, which can be potentialized if the Real rallies or sells off aggressively in face of the results.
The scenario that’s developing leans more to Lula's favor, which can generate a negative driver for the Real and positive for coffee from next month. Be aware, however, that there are many other influences acting upon coffee at the moment.
We mentioned above, the record low and lowering certs, there is also Brazilian weather, the calendar spreads, the coming October crops, technicals, the Fed and USD, inflation, recession risks and many other factors.
A movement in the BRL won't necessarily be the dominant influence with coffee, but the historical correlation is definitely there. It’s a strong possibility that if the Brazilian FX markets heats up from the election, coffee will get burned.
However, let’s keep some perspective. For now, the elections are likely to be short-term noise rather than a decisive factor for the future of the BRL. If Bolsonaro wins: it’s likely that the BRL follows the same course it was already headed, despite the short-term relief we received last week. If Lula wins, however, it can be an additional long-term negative fuel to the BRL and bearish for KC.
Comments