Brazil's landmark labor reform bill, intended to relax the country's restrictive labor laws and a main plank of embattled President Michel Temer's efforts to bolster investment and pull the economy out of its worst recession ever and widely seen as the country's second most important reform agenda after the Pension bill, was unexpectedly rejected by a special committee in Brazil's senate, with 10 votes against it, 9 in favor and 1 abstention. 

Prior to the vote, local newspaper O Globo reported that the government believed text of the labor reform will be approved in Senate’s Social Affairs Committee in a tight vote of about 11 in favor vs 8 against, setting market expectations.

In immediate kneejerk reaction, stocks dropped as much as 1.4%, while the BRL is leading declines among major currencies, down 1.6%, from drop of ~0.8% before vote. The committee was 2nd of the 3 bill had to clear before going to Senate floor vote. The failure to pass, strikes a major blow to Temer's reform policy and puts into question whether Brazil will be able to "sell" its economic improvement to potential investors.

According to Citi, the rejection could result in the reform effort being delayed. However Committees have no terminating character, Senate general secretary Luiz Fernanddo Bandeira de Mello noted. The bill will now go to the Senate Constitution and Justice Committee and then the Senate floor's assessment.  Nevertheless the rejection is likely to be a further blow to the government, amid other political noise embroiling President Temer.

The labor bill is fiercely opposed by unions because it would abolish mandatory payment of union dues by Brazilian workers.

In April, Brazil's lower house approved the labor bill, seen as a barometer of support for Temer, two days before a national strike and demonstrations called by labor unions and leftist parties to protest Temer's reform program that they say undermines workers' rights to the benefit of business interests. Backers of the labor bill say it will modernize employment rules that date from the 1950s and encourage investment by lowering labor costs for businesses.

If it had been passed by the Senate, the measure would relax restrictions on temporary workers, introduce guarantees for outsourced work and let collective bargaining agreements between unions and employers override some rules of the labor code. Now that it has failed to gain passage, Temer's entire economic agenda is suddenly in limbo.