Conventional wisdom has been that a Brazil loss at home in the World Cup would be a positive for the country's financial markets. A defeat, the argument went, would sour the national mood and prompt voters to oust President Dilma Rousseff, who has sunk the economy into stagflation.

Yesterday's 7-1 loss to Germany, though, was so crushing that it upends that theory, according to Geoffrey Dennis, the head of emerging-market strategy at UBS, who's been covering Brazil since the early 1990s. Yes, the defeat will hurt Rousseff's chances at re-election in October, but the lopsided outcome at the same time could deal a blow to investor and consumer confidence in a country that obsesses about its national pastime, he said.

“It is such a humiliating defeat that you wonder whether it will have a negative impact on Brazilians’ psyche,” Dennis said in a telephone interview from Boston. “It’s going to confirm to the people that ‘Look, our economy is struggling, we cannot get any growth, now we don’t even have a decent football team either.’”

With Brazilian markets closed today for a holiday, the impact on asset prices may show up in the country's overseas bonds as well as American depositary receipts of state-controlled companies such as Petroleo Brasileiro SA. The benchmark Ibovespa stock index has gained 19 per cent from a low on March 14th as Rousseff's declining popularity sparked speculation that new administration would take over and help jumpstart the economy.

Worst loss

Since Rousseff took office in 2011, growth has decelerated to an average annual rate of 2 per cent, the slowest for a Brazilian president since Fernando Collor, who resigned in 1992 amid corruption allegations. Her policies aimed at reviving the economy have stoked annual inflation exceeding 6.5 per cent, the upper limit of the government’s target range.

Yesterday’s loss, the worst defeat in the country’s history, dashed Brazil’s hopes of overcoming the national tragedy of losing the final match of the 1950 World Cup at home. Brazil will now play for third place in the tournament on July 12th.

Street protests

After the match, officials reported isolated disturbances, with military police in Rio saying some fans fled a viewing party on Copacabana beach after a fight broke out. Globo News showed images of buses burning in Sao Paulo, though it wasn’t immediately clear if the vandalism was a reaction to the game.

The loss "is nothing short of a national humiliation," Tony Volpon, the head of Americas research at Nomura Holdings Inc. in New York, said in an e-mailed note. "For a country that defines so much of its national character around its footballing prowess, losing at home cannot but have major repercussions beyond the acts of violence seen after the defeat."

Sell real

As the Brazilian team was thrashed by its opponents yesterday, some in the stadium jeered Rousseff, who had promised to host the “cup of cups.” She wrote on her Twitter account that she was saddened by the defeat, also using lyrics of a popular Brazilian song to urge the nation to overcome the loss.

The game may ultimately cost Rousseff the election, which will in turn spur a 25 per cent rally in Brazilian stocks, according to Alberto Bernal, the head of research at Bulltick Capital Markets.

“This is going to be catastrophic for the national mood,” Bernal said by phone from Miami yesterday. “If the market sees the potential that Dilma will not be re-elected, then it will rally in a big way.”

Brazilian markets may come under pressure if the defeat sends protesters to the streets while failing to put a meaningful dent in Rousseff's popularity, an "unfortunate combination of structural worries and diminished hope for new policies," Eamon Aghdasi, a strategist at Societe Generale SA in New York, wrote in a report yesterday. He recommends selling Brazil's real versus the Mexican peso.

Dennis, a UK national who supported Germany because his grandchildren live there, said the psychological burden of the defeat may take a while for Brazilians to overcome.

“I do not think this result leads to a knee-jerk rally in markets,” Dennis said. “Brazil has to get over this massive loss.”

Bloomberg