Lula v. the bond market

James Carville, the legendary political consultant for the U.S. Democratic Party, once said: “I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a .400 baseball hitter. But now, I would want to come back as the bond market. You can intimidate everybody.” 

The Brazilian bond market has been indeed quite intimidating since Luiz Inácio Lula da Silva was elected president for the third time in October of last year. In November, the ten-year benchmark annual yield for local government bonds rose from 11.9 percent to a peak of 13.9 percent, a huge risk repricing for such a short span. 

Future interest rates have been very volatile and reactive to political headlines ever since. The narrative moved from the post-election euphoria — when it seemed that Henrique Meirelles, a highly respected former central banker and finance minister, would be Lula’s pick to run the economy — to reluctance, with the nomination of a Finance Ministry team with no first-rank names linked to traditional orthodox academic centers or financial markets. 

Then, it hit outright depression in the first week of 2023, with a cacophony of voices linked to the new government asking for more unfunded expenses and even calling for the revocation of some of the pro-market reforms enacted during the Michel Temer (2016-2018) and Jair Bolsonaro (2019-2022) administrations.

Market rates got some relief after the first general cabinet meeting summoned by Lula on January 6, and kept falling on Fernando Haddad’s announcement of a short-term fiscal plan that aims to more than halve this year’s primary (i.e., excluding debt service) public deficit from the 2.2 percent of GDP implied by the budget law.

However, risk premia remain high across Brazilian assets. 

A one-year real interest rate market proxy stands at 7.5 percent, whereas in...