Brazil's risk premium hits lowest level since pre-pandemic as markets bet on steeper rate cuts.

Brazil's country risk fell this week to roughly 110 basis points on the CDS — the lowest level since February 2020, before the pandemic — and that figure, more than any other single data point, captures the shift in sentiment running through the domestic market. The Ibovespa closed Thursday's session up 0.93% at 206,222 points, propped up by Petrobras shares, whose ADRs mirrored the surge in oil above US$104 amid escalating tensions in the Middle East and the secondary effects of the Iran War on maritime freight. The dollar advanced in the same session, but the currency move was overshadowed by the small-caps rally, which rose 12% between Monday and Wednesday — a phenomenon that, according to Fernando Ferreira, chief strategist at XP, reflects a growing market bet on a steeper trajectory of Selic cuts than was priced in before the first round of the presidential election.

It is at this intersection of short-term optimism and structural uncertainty that Brazil finds itself today. The National Treasury itself captured the risk appetite by selling R$33.28 billion in fixed-rate bonds on Thursday — the largest volume in a first auction round since December 2020 — in an operation combining R$27.86 billion in LTNs and R$5.43 billion in NTN-Fs with maturities between 2028 and 2037. The result signals that institutional investors are willing to lock in rates over long horizons, betting that the rate cycle will converge downward. But UNCTAD, in its annual Trade and Development Report 2026 released this Friday, offers a more sober perspective: after 2.3% growth in 2025, Brazilian GDP is projected to decelerate to 1.8% in 2026 and 1.5% in 2027 — projections that contrast with current market optimism and serve as a reminder that this week's rally was fueled by electoral expectations, not by a revision of the economy's structural outlook.

The electoral scenario dominates the immediate horizon. Consumption tax reform returned to the center of the political debate less than three weeks before the runoff, with Flávio Bolsonaro's (PL) campaign stating that the candidate intends to eliminate the split payment mechanism — whereby the tax is collected directly at the moment of financial transaction, before it reaches the selling company. Finance Minister Dario Durigan responded sharply, stating that being against split payment is "favoring those who commit fraud." Jurists linked to the Centro de Cidadania Fiscal, the entity that conceived the model, go further: they argue that not even a constitutional amendment could repeal the reform, given that its foundations are already embedded in the Constitution's entrenched clauses. Durigan, for his part, pledged to send the "sin tax" provisional measure to Congress only after the runoff, signaling that the government prefers to avoid additional friction during the most sensitive period of the electoral calendar, though he claims to have reached an agreement with the affected sectors.

The tension between the fiscal agenda and political pressures is also manifesting in the relationship between the Executive and the Judiciary. The Lula administration placed R$731.9 million of the 2027 budget earmarked for the CVM into reserve, in practice ignoring a ruling by Justice Flávio Dino of the STF, who had ordered those funds to be made available to the capital markets regulator. The budget maneuver casts a shadow over the autonomy of an institution central to the functioning of capital markets at a moment when the country is celebrating its proximity to investment grade.

In commodities, the day crystallizes a set of pressures that extend well beyond oil. Brazilian exports of the three main animal proteins — beef, pork, and poultry — fell 15% in revenue and 12% in volume in September compared with the same period in 2025, penalized simultaneously by Chinese restrictions and the suspension of European certifications. Development Minister Márcio Rosa said he sees progress in negotiations with Brussels, but the impasse remains unresolved. In the iron ore sector, the situation is equally delicate: maritime freight on the Brazil-China route already exceeds US$40 per ton — double the January level — while commodity prices fluctuate below US$100 in China, squeezing the profitability of operators such as Musa, CSN Mineração, and Itaminas, which have already announced temporary production cuts.

The Brazilian steel industry, in turn, is seeking tariff protection and a sectoral support package — ProAço — similar to the chemical industry's Presiq, in the face of a flood of subsidized Chinese steel in a market operating with more than a third of its capacity idle. Anglo American, meanwhile, raised the pressure on European regulators by stating that it will shut down its nickel operations in Goiás if the European Union blocks the sale of the unit to China's MMG — a threat that connects the geopolitics of critical raw materials directly to the industrial map of Brazil's Center-West.

Two events this week nicely illustrate what Brazil has to offer when operating at full capacity. Embraer delivered to Latam the first of 24 E195-E2 jets from a US$2.1 billion contract, and its ADRs on the NYSE surged more than 5% on Thursday after the inaugural flight of the first Gripen fighter manufactured entirely in Brazil — an industrial milestone that reinforces the company's position in the global defense segment precisely as military budgets expand around the world. Petrobras, whose shares also trade on the NYSE, won 21 of the 56 blocks offered at the ANP auctions, securing R$3.2 billion of the R$3.5 billion raised in total for the government and consolidating its dominant position in the Campos Basin.

What to watch in the coming sessions: the release of September's IPCA, with market consensus around 0.75% — and an Itaú projection of 0.79%, which would push 12-month accumulated inflation to 4.5% — will be the immediate test for the rate-cut narrative fueling the small-caps rally. In addition, the outcome of the electoral runoff will define not only the fate of tax reform and split payment, but also the direction of fiscal policy in an environment where public debt remains the main medium-term risk variable. The evolution of trade negotiations with the European Union — on both meat and nickel — and the trajectory of oil amid a persistent regional conflict round out the set of variables the market will have to price in the weeks ahead.