Severe sell-off across Argentina looks overdone; caution still needed

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The recent tumble and sell-off across Argentina assets on concerns over a shift to a populist regime that could rumble its relationship with the IMF looks overdone. While clear risks remain around Argentina’s weak fundamentals and an uncertain political environment, there is also potential for some recovery from current depressed levels. A more moderate tone from the frontrunner in the presidential race and emergency measures could help calm market fears. Widespread contagion to the emerging market segment should not be expected.

  • Incumbent president under pressure from economic recession and general dissatisfaction with government
  • Concerns about longer-term debt sustainability
  • The market overreacted, but risks remain
  • Broader contagion looks unlikely

Primary elections on 11 August saw the incumbent president Mauricio Macri suffer a resounding defeat to rival Alberto Fernandez. The magnitude of the defeat was significant: if the 27 October general election results in Fernandez attracting a similar size portion of the vote, he would be the outright winner and avoid a second round run-off.

Financial markets had not anticipated this and concerns around a leadership change led to a significant sell-off of Argentina assets, including the currency, which fell by more than 15% against the US dollar. The main concern is policy discontinuity under a left-wing Fernandez administration, which looks set to include his running mate and former President Cristina Kirchner.

Exhibit 1: Argentina stocks and the peso sold off after the unexpected primary results (1 July 2018-19 Aug 2019)

Exhibit 1: Argentina stocks and the peso sold off after the unexpected primary election results (1 July 2018-19 Aug 2019)

Market foresees more nationalist policies

The market is now pricing a Fernandez win in the first round combined with a rapid deterioration in policymaking. Market concerns include more protectionist policies, undoing some of the hard fought gains by the Macri presidency and an increased willingness to default on debt.

We remain cautious on Argentina’s outlook, but we feel the market has overreacted to the news. While near-term market noise is likely to remain elevated, we would note that since the election outcome, Fernandez’s rhetoric has become more moderate, indicating that he will work on renegotiating a loan from the IMF and does not intend to default on outstanding debt.

A messy default would also not be in the best interest of the IMF. In the event of a Fernandez victory, a pragmatic approach from both Fernandez and the IMF could prevent a default and lead to additional disbursement from the IMF. This  would be a much better outcome than the market currently expects.

Reassurances likely

In addition, we expect near-term policy reaction to try and calm the markets. This could lead to a relief rally. Furthermore, we would expect less bond issuance and less aggressive leverage under a Fernandez government than under a second Macri mandate. This would render the market technicals more favourable.

There are key risks around Argentina to be mindful of, including rapid inflation, currency depreciation, high foreign debt levels and slowing growth. These can trigger a liquidity and solvency crisis and we take these into account in our risk and scenario assessment when formulating investment decisions. In particular, we remain cautious on the local currency denominated side where bonds and the currency could come under significant additional pressure.

Broader contagion fears?

While the current sell-off is specific to Argentina, we note slightly weaker market sentiment across the broader emerging market debt complex. This has been exacerbated by recent escalation in US-China trade tensions as well as low trading volumes on account of the summer seasonality effects.

However, we do not expect large-scale contagion. Argentina’s fundamental issues and potential political risks have been largely well documented by the market. Positioning in the EMD space as a whole has also not been overcrowded.

At the time of writing, President Trump’s announcement of delays on tariffs on selected products from China as well as temporary permission for Chinese telecom giant Huawei to continue to do business with US firms should provide some near-term relief to the wider market.

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Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients.

The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay.

Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher than average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity, or due to greater sensitivity to changes in market conditions (social, political and economic conditions).

Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.

Karan Talwar

Emerging Markets Fixed Income Investment Specialist

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