When we wrote about the wave of elections coming to Latin America this year, Argentina was one of the few countries not going to the polls. Investors in Argentina have been voting, however—with their feet. By last week, the Argentinean peso (ARS) had lost a quarter of its value against the U.S. dollar since the start of the year.
A strengthening dollar has pressured emerging markets assets and currencies for a couple of months now, but poor communication, lack of coordination, policy missteps and delayed action from Argentina’s central bank have left it particularly exposed.
In some ways, the current crisis resembles the “bad old days” for this economy. But two developments last week reassure us that this time can be different: talks on a standby loan program with the International Monetary Fund and the successful rollover of ARS621 billion (USD26 billion) in short-term local-currency notes known as LEBACs.
Following over a decade of economy-stifling policies before President Mauricio Macri was elected in 2015, Argentina has the potential to reap significant benefits from multiyear policy changes and reform. As the country moves through this adjustment period, however, it has faced headwinds in managing its fiscal and monetary policy, and the flow-through of reform to the real economy is taking time. In particular, inflation, still printing at around 25% year-over-year, has declined more slowly than expected. The central bank arguably exacerbated this by raising its 2018 inflation target to lay the groundwork for a rate cut in January.
As the sell-off began, it was soon evident that the central bank’s heavy currency market interventions were not going to stem the flow. Stronger, coordinated measures followed, straight out of the textbook. The central bank hiked rates by 12.75 percentage points to 40%, intervened to push up rates in the bill market and support FX futures, and sold close to 5% of its foreign currency reserves. The government tightened its primary fiscal deficit target by 0.5 percentage points to 2.7%, started talks with the IMF and accepted a $2 billion line of credit with the Bank of International Settlements.
These were substantial and welcome actions. Calling on the IMF was particularly significant and underlines the Macri administration’s technocratic credentials as it is likely to carry a huge political cost. Recall that the previous, Kirchner Fernandez regime’s platform was in no small part based on blaming IMF-prescribed policies for the catastrophic economic collapse in 2001, going so far as to prepay in full, at a large financial cost, to avoid the IMF’s conditionality and monitoring.
Nonetheless, uncertainty about the impact of these measures has left market participants jittery.
The Current Crisis Appears Manageable
We believe the investment case for Argentine sovereign debt still stands.
We think the recent policy interventions will help minimize further depreciation of the currency and stabilize Argentina’s credit risk in the short run. One advantage of having been locked out of international bond markets since the default of 2001 is that the country has relatively low debt, at just over 50% of GDP. Last week’s rollover of LEBACs was achieved at an interest rate of 40%, which is less than that demanded by the secondary market. It was accompanied by a successful issue of around $3 billion worth of five- and eight-year local currency bonds. That suggests a certain level of investor confidence that the current crisis will remain manageable.
We also maintain that the Macri administration can achieve reform progress. The fact that the next election is not due until late 2019 should help buy time for markets to adjust and allow some benefits of reform to show through.
Should those reforms stay on track, they stand to benefit some key corporate sectors, especially oil and gas, utilities and natural gas production, where prices are being liberalized and concessions are being offered to meet demand for power. We acknowledge that the rapid devaluation of the peso could have an impact on these industries, but overall, the environment remains supportive.
Nonetheless, there is no doubt that the central bank’s reputation has suffered, and concerns have been raised about its independence. While we consider spreads on hard currency bonds to be attractive, this has left the local currency market vulnerable to additional shocks, because local currency investors are particularly wary of short-term impacts on their portfolios. In this sector, therefore, we remain more cautious.
In Case You Missed It
- U.S. Retail Sales: +0.3% in April
- NAHB Housing Market Index: +2 to 70 in May
- Euro Zone 1Q18 GDP (second estimate) : +2.5% annualized rate
- Japan 1Q18 GDP (first estimate): -0.6% annualized rate
- U.S. Housing Starts: -3.7% to SAAR of 1.29 million units in April
- U.S. Building Permits: -1.8% to SAAR of 1.35 million units in April
- Euro Zone Consumer Price Index: +0.3% in April month-over-month and +1.2% year-over-year
- Japan Consumer Price Index: -0.4% in April month-over-month and +0.7% year-over-year
What to Watch For
- Wednesday, 5/23:
- U.S. New Home Sales
- Thursday, 5/24:
- U.S. Existing Home Sales
Statistics on the Current State of the Market – as of May 18, 2018
|S&P 500 Index||-0.5%||2.6%||2.2%|
|Russell 1000 Index||-0.4%||2.7%||2.4%|
|Russell 1000 Growth Index||-0.4%||3.8%||5.6%|
|Russell 1000 Value Index||-0.3%||1.6%||-0.9%|
|Russell 2000 Index||1.3%||5.6%||6.4%|
|MSCI World Index||-0.4%||1.9%||2.0%|
|MSCI EAFE Index||-0.5%||0.7%||1.6%|
|MSCI Emerging Markets Index||-2.3%||-2.2%||-1.2%|
|STOXX Europe 600||-0.8%||0.3%||1.0%|
|FTSE 100 Index||0.8%||4.0%||3.1%|
|CSI 300 Index||0.8%||4.0%||-3.0%|
|Fixed Income & Currency|
|Citigroup 2-Year Treasury Index||0.0%||0.0%||-0.3%|
|Citigroup 10-Year Treasury Index||-0.8%||-1.1%||-4.8%|
|Bloomberg Barclays Municipal Bond Index||-0.4%||0.3%||-1.2%|
|Bloomberg Barclays US Aggregate Bond Index||-0.5%||-0.5%||-2.7%|
|Bloomberg Barclays Global Aggregate Index||-1.1%||-1.6%||-1.8%|
|S&P/LSTA U.S. Leveraged Loan 100 Index||0.0%||0.0%||1.9%|
|ICE BofA Merrill Lynch U.S. High Yield Index||-0.2%||0.0%||-0.3%|
|ICE BofA Merrill Lynch Global High Yield Index||-0.5%||-0.8%||-1.0%|
|JP Morgan EMBI Global Diversified Index||-0.9%||-1.7%||-4.8%|
|JP Morgan GBI-EM Global Diversified Index||-3.5%||-5.4%||-4.1%|
|U.S. Dollar per British Pounds||-0.6%||-2.2%||-0.4%|
|U.S. Dollar per Euro||-1.5%||-2.6%||-2.0%|
|U.S. Dollar per Japanese Yen||-1.2%||-1.1%||1.8%|
|Real & Alternative Assets|
|Alerian MLP Index||3.1%||5.3%||1.1%|
|FTSE EPRA/NAREIT North America Index||-3.2%||0.0%||-6.3%|
|FTSE EPRA/NAREIT Global Index||-2.1%||-0.6%||-2.3%|
|Bloomberg Commodity Index||0.5%||1.0%||3.2%|
|Gold (NYM $/ozt) Continuous Future||-2.2%||-2.1%||-1.4%|
|Crude Oil (NYM $/bbl) Continuous Future||0.8%||4.0%||18.0%|
Source: FactSet, Neuberger Berman.