(Bloomberg) -- From prison to the presidency, Brazil’s Luiz Inacio Lula da Silva has turned to one ally more than any other in moments of need: Fernando Haddad, the once and potentially future political heir he named his finance minister.

Now Brazil’s increasingly cloudy fiscal outlook is poised to put their relationship through its toughest test.

Haddad last week weakened the government’s primary 2025 budget target, a tacit admission that his plans to shore up public accounts without significant spending cuts are falling short of his lofty goals.

The timing for markets couldn’t have been worse. The change added to upheaval sparked by the Federal Reserve’s indications that US interest rates will remain higher for longer, jitters around the upcoming power transition at Brazil’s central bank, and tensions in the Middle East. The real weakened while pressure on the long-end of Brazil’s swap curve increased.

The negative reaction, investors say, was largely a result of the global tumult caused by the Fed’s renewed caution, not a loss in confidence in Haddad: Until the US starts cutting, “the market will always look at any situation as glass half-empty,” said Bruno Stuani, a director at Plural Gestao, a Sao Paulo-based investment unit of the brokerage Genial Investimentos.

But Brazilian markets performed particularly poorly amid worries that the combination of renewed fiscal concerns and international uncertainty might force the central bank to slow the pace of its own easing cycle, adding additional pressure to Latin America’s largest economy.

Lula has so far backed Haddad’s efforts to strike a delicate balance between investors who want more fiscal discipline and leftist allies — many of whom see the minister’s approach as too market-friendly — pushing to spend more. Now both groups are watching to see how the performance of the economy might shape the president’s trust in Haddad’s strategy, especially as declining approval ratings feed Lula’s desires to use spending to deliver the prosperity he promised.

Internal Battles

Haddad, who holds a Ph.D in philosophy, has always been a somewhat awkward fit in a party defined by working class politics. But Lula has long viewed him as the best-prepared of a new generation of leaders on the left, and their relationship deepened during president’s stint in prison after his 2017 corruption conviction. Haddad replaced his mentor as the party’s 2018 presidential candidate; despite his defeat, he is considered a frontrunner in the race to assume Lula’s mantle in the future.

In a cabinet marked by rivalries and public squabbling, Haddad has emerged as perhaps the only minister that truly has Lula’s ear, multiple people inside the administration said, requesting anonymity to discuss internal matters. 

A president famous for stoking debates among his advisers has tended to land on Haddad’s side during his third term: The minister has so far won battles over fuel tax subsidies, the 2024 fiscal target and the government’s overall economic strategy. He shaped Lula’s response to a recent fight over the top job at state-run oil giant Petroleo Brasileiro SA. He earned another win late last week when Petrobras’s board backed a partial payout of extraordinary dividends, settling a dispute that had roiled markets with a plan Haddad helped develop.

Some of his fellow ministers now view Haddad as a conduit to Lula, the people said. But others on the left have made it clear for more than a year that they see his fiscal efforts as a threat to the growth and expanded social welfare programs Lula promised.

Sluggish projections for this year have already caused Lula to ramp up pressure on Haddad to spend more to boost the economy, generating a sense among some Workers’ Party members who favor its traditional invest-to-grow approach that momentum is now on their side. The target change also intensified views among Haddad’s critics on the left that his new spending rules were a mistake. A crisis between the government and congressional leaders, meanwhile, has suddenly added to the fiscal headaches.

That has sparked concerns among investors, many of whom see Haddad as the most credible member of the government. 

But even amid the turbulence, some analysts say it is too soon to worry about a major strategic shift. Brazil may not be experiencing the boom Lula wants, but its broader economic outlook is improving: The central bank recently boosted its 2024 growth forecast, while economists it surveys weekly have revised their estimates upward nine consecutive times. 

“At the end of the day, we are in a scenario where growth is still surprising to the upside,” said Christopher Garman, a managing director at the Eurasia Group. “So there is no panic in the presidential palace.”

--With assistance from Josue Leonel.

©2024 Bloomberg L.P.