- The surge happened: The future yield curve dropped following the first-round results, and fixed-rate and inflation-linked government bonds posted substantial mark-to-market gains.
- The manager dilemma: According to InfoMoney reporting, the market is split between those who believe the political victory is already priced in and those demanding to see a fiscal plan before believing it.
- What to do: Locking in part of the gains on long-term paper or focusing on the carry of floating-rate and medium-term hybrid bonds prevents investors from getting caught off guard by the election.
The sharp drop in future interest rates after the first round delivered quick profits for investors positioned in long-term fixed income, but buying now requires understanding that much of the optimism is already baked into prices.
What happened to fixed income after the first round?
Brazilian fixed income posted a sharp mark-to-market gain right after the first round of voting. The financial market reacted with immediate relief to the composition of Congress and Flávio's lead in the polls, which pulled down future interest rates across the entire curve and sent the unit prices of fixed-rate and inflation-linked IPCA+ bonds soaring.
This move rewarded investors who bought bonds when yields were stretched prior to the vote. However, according to InfoMoney reporting gathered from asset managers, the market has started questioning whether the move happened too fast. When future interest rates fall rapidly, bond prices rise on screen, but new purchases offer a lower yield to maturity.
The question dividing trading desks right now is whether there is still room for rates to fall further or if retail investors are buying bonds in a wave of euphoria, right on the eve of a runoff election that carries fundamental uncertainties.
How much of Flávio's victory is already priced in?
For a significant portion of the managers interviewed by InfoMoney, the electoral favoritism has already been largely priced in. The drop in rates reflected the bet that the future administration will have a favorable majority in the National Congress to curb spending and unblock reforms, reducing the risk of public debt insolvency.
However, another relevant group of managers is adopting a more conservative stance. In this wing's view, politics won the first battle, but the economy still has to be delivered. The yield curve reacted to expectations, but the next president will have to present heavy-hitting names for the economic team and tough fiscal measures in the very first months to justify keeping these low risk premiums.
The winner confirms a Finance Minister backed by the market, presents tangible spending cuts, and inflation converges, allowing for a more aggressive rate cut by the Central Bank.
Campaign rhetoric fails to translate into real fiscal measures, budget concessions emerge, and future interest rates rise again, erasing recent mark-to-market gains.
This divergence shows that fixed income is not a done deal. Anyone entering fixed-rate or long-term bonds now is paying a much higher price than three weeks ago, taking on the risk of seeing yields drop if fiscal delivery disappoints.
How does each bond type stand ahead of the runoff?
Not every fixed-income bond reacts the same way to the heat of the ballot box and market sentiment. Your portfolio's composition needs to balance the pursuit of capital appreciation with the protection of accumulated capital.
Public and private debt instruments respond to opposing forces. While inflation-linked bonds preserve purchasing power even during crises, fixed-rate bonds require absolute conviction that inflation and the Selic rate will not rise again.
Meanwhile, floating-rate bonds keep liquidity shielded from sharp swings, serving as a safe harbor while the political landscape remains unsettled.
- Floating-rate (Tesouro Selic / 100% CDI CDs): Continue paying double-digit returns with no risk of negative price fluctuations.
- Medium-term IPCA+ (3 to 5 years): Secure a healthy real yield above inflation without exposing investors to the extreme volatility of 20-year maturities.
- Long-term fixed-rate bonds (above 5 years): Have lost much of their tactical appeal and remain vulnerable if the fiscal outlook sours.
The golden rule in this moment of uncertainty is not to get blinded by the rear-view mirror. Recent past mark-to-market returns will not repeat themselves easily without new, concrete positive developments on the public finance front.
Watch out for excessive duration: Tesouro IPCA+ bonds maturing after 2035 or 2045 have very high duration. If fiscal perception worsens in the runoff and the required yield rises by just 0.50 percentage points, the screen prices of these bonds can drop by more than 6% in a matter of days.
What does this change for retail investors?
For those who do not make a living speculating on fixed-income desks, the decision centers on the money's purpose and available time horizon. Ordinary investors do not need to guess the election outcome if their portfolios are properly aligned with fundamentals.
If you bought long-term bonds solely to capture quick mark-to-market profits, it may make sense to realize at least part of the gain before the election. However, if your focus is holding to maturity with a high real yield, there is no reason to panic: maintain your position and direct new monthly contributions toward floating-rate or medium-term inflation-linked bonds.
Retail investors frequently make the mistake of chasing the bond that rallied the hardest the previous week. With the country's nominal interest rates still quite high, patience is generously rewarded in the market's simplest and safest instruments.
What to monitor from here on out?
The key to the next steps for fixed income will be the transition from the campaign trail to government formation. The announcements that follow the runoff election results will determine whether interest rates continue on a downward path or stall at a defensive level.
The first gauge will be the appointment of candidates for the Ministry of Finance and the Ministry of Planning. The market demands profiles with a proven commitment to public debt sustainability and technical independence.
The second decisive trigger will be the target plan for gross debt relative to GDP. Without a credible fiscal anchor that sets strict ceilings or limits on mandatory spending, the relief gained on the yield curve after the first round could quickly reverse.
Verdict: Fixed income rallied significantly after the first round, but prudent investors should not buy long-term fixed-rate bonds at the peak of optimism. Take advantage of attractive real yields in medium-term inflation-linked bonds and keep a substantial reserve in floating-rate investments to navigate the runoff without portfolio shocks.