EM FI/FX Strategy Brazil: At a multi-year inflection point—what is priced?

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EM FI/FX Strategy Brazil: At a multi-year inflection point—what is priced?

a rally of ~300bp at the back end. Front-end real rates could also compress by as much

as 500bp, although such an adjustment would likely occur in stages as fiscal credibility

improves. The resulting repricing should provide support across the curve. Consistent

with these views, we remain long 10y bonds, with the elections as the main catalyst for

repricing.

Lower rates could support a broader rerating of Brazilian equities

In equities, we remain OW Brazil. Like local rates, Brazilian equities appear to be pricing

a meaningful fiscal risk premium. Brazilian banks trade at roughly a 40% discount to

global peers despite stronger earnings-growth prospects. Our equity research team

argues that much of this valuation gap reflects elevated cost-of-equity assumptions

rather than weaker fundamentals – note that asset quality remains a relevant concern,

but we believe it is already priced in (see more details on “Household credit traffic

light”). In this context, a 100bp decline in the cost of equity could lift fair values by

roughly 12–14% for incumbent banks and by as much as 20% for longer-duration

names such as Nu. UBS equity research maintains Buy ratings on Nu, XP, Santander Brasil

and Bradesco. Given that financials account for approximately 40% of MSCI Brazil,

lower rates could support a broader rerating of the local equity market. Our equity team

also maintains a Buy rating on Petrobras. Historically, election-related repricing has been

concentrated before and in between election rounds, with forward EV/EBITDA multiples

typically moving by 0.3x–1.0x between the first and second rounds. Thereafter,

valuation tends to be driven more by capital-allocation and shareholder-return policies