Real Volatility Rises on Bolsonaro's Endorsement of Flávio

Brazilian traders are increasingly hedging against a potential drop in the real after Jair Bolsonaro endorsed his son Flávio in the 2026 election, upending earlier optimism around a stable political landscape. This shift in political support has led to a sharp rise in the 25-delta risk reversal indicator, a measure of market sentiment, which hit 3.9% after Flávio's announcement on December 5 - the highest level since July 2020. The indicator suggests traders now see a higher probability of the real depreciating against the U.S. dollar.

Implied volatility for real options has also jumped to 12.6%, nearing levels last seen in October and far above the muted volatility seen in other emerging-market currencies. Analysts argue that the recent political developments have disrupted the market's once-rosy view of Brazil's path to the election. "The abrupt selloff confirms that markets had become far too complacent," said Thierry Larose, a portfolio manager at Vontobel Asset Management.

The market reaction has also prompted strategic adjustments among institutional investors. Vontobel recently returned to buying the real against the dollar after trimming its position in November, while others are incorporating risk-reversal trades to guard against political surprises. Brendan McKenna of Wells Fargo noted that the real's valuation appears stretched, and political and fiscal risks remain as the 2026 election approaches.

How Markets Reacted

Brazil's real has weakened more than 4% since Flávio Bolsonaro's announcement, trading near 5.50 per dollar despite a 13% gain earlier this year. The currency's performance has drawn attention from traders and analysts, many of whom view the recent move as a correction after a period of strong appreciation. Olga Yangol of Crédit Agricole explained that combining a long-real position with a risk-reversal trade offers protection against Brazil's unpredictable political climate.

The shift in investor behavior is evident in the broader market. The 25-delta risk reversal and implied volatility levels now diverge from the more stable emerging-market peers, highlighting Brazil's unique exposure to domestic political developments. Analysts expect this trend to continue if uncertainty persists around the election or if fiscal policy remains unclear.

What Analysts Are Watching

With the 2026 election approaching, analysts are closely monitoring how political developments might shape Brazil's economic trajectory. The Bolsonaro endorsement has reignited concerns about policy continuity and investor confidence, particularly given the country's history of political turbulence. "Political and fiscal risks won't disappear," said McKenna. "As these risks materialize, the high risk reversal is likely to rise further."

Another key focus is whether the real's recent selloff is a temporary correction or a more significant shift in market sentiment. Vontobel's Larose noted that the firm's decision to re-enter the real-dollar trade was based on a reassessment of risk rather than a change in the currency's fundamentals. However, given Brazil's political volatility, any new developments could quickly alter the balance between buyers and sellers of the real.

Traders are also watching for any policy adjustments that might emerge as the election campaign intensifies. While the Bolsonaro camp represents one faction, other candidates, including Tarcisio de Freitas, could shift the political landscape further. For now, the market remains in a state of cautious observation, with risk-reversal positions serving as a buffer against unexpected developments.