Why you should care
The country’s currency is steadying at a low point, creating the best buying opportunity for some investors.
Just days after panic swept through Argentine financial markets, some investors see pockets of opportunity while also facing the difficulty of trading in an environment distinguished by the evaporation of price liquidity. Against this backdrop even small trades can move market prices sharply, making any substantial changes to a portfolio difficult to implement. While Argentine markets and many areas of emerging markets are never the most liquid, the dismal trading conditions have once again reminded fund managers that they can no longer rely on regulation-constrained banks to ensure markets function smoothly.
This sudden deterioration of “liquidity” — a term for the tradeability of markets — has been a phenomenon across emerging markets this summer, according to Gene Frieda, a Pimco strategist. “We’ve had a series of idiosyncratic shocks, but the surprise is the magnitude of the moves,” says Frieda. Still, there are nascent signs of stability in the wake of the Argentine government’s announcement that it aims to eliminate its primary fiscal deficit by next year — the gap between spending and income before taking debt servicing into account. The International Monetary Fund’s promise to revise its $50 billion aid program swiftly has also helped stabilize markets.
The Argentine peso has steadied around 37 per U.S. dollar, the Merval stock market has bounced off its lows, and the dollar-denominated 10-year government bond yield has fallen from a high of nearly 11 percent to about 10 percent. Even the 100-year “century bond” issued at the peak of investor enthusiasm for Argentina in 2017 has found a floor above 70 cents, equating to a yield of 10 percent.
Hence some investors are looking for bargains.
For the first time in a long time, the peso is cheap.
Diego Ferro, co–chief investment officer, Greylock Capital
“I view this not only as a buying opportunity but as the best buying opportunity in 16 years,” says Jan Dehn, global head of research at asset manager Ashmore, with an eye to Argentina’s 2002 devaluation.
Dehn cautions that the peso might take another leg down, given a recession is all but guaranteed to hit Argentina’s economy this year, but argues there has been an overselling of riskier emerging markets due to a misguided perception that the U.S. dollar is set to strengthen indefinitely.
Diego Ferro, co–chief investment officer at Greylock Capital, sees similar value in the country. “For the first time in a long time, the peso is cheap,” he argues. “That doesn’t mean it can’t get cheaper, but with rates as high as they are, getting into pesos will eventually be a great deal.”
Moreover, the devaluation has helped the country eliminate a significant portion of its current account deficit and improve its creditworthiness, adds Ferro: “The market is producing a big part of the adjustment that the economy needed, and if the government can fix the fiscal hole, the country looks far more sustainable now than a year ago.”
But other investors remain wary of Argentina — and emerging markets in general.
Concerns over Argentina have been mounting for most of 2018, swelling the value of credit default swaps referencing the country’s bonds from a net notional value of $3 billion in March this year to more than $5 billion at the start of September.
But the crisis sent the cost of Argentine credit default swaps spiraling from about 250 basis points at the start of August to a high of 877 basis points in recent weeks — soaring past Lebanon, Turkey, Pakistan and Iraq to a level only behind Venezuela, which has already shirked its repayments.
Rising U.S. interest rates and the dollar’s renaissance have roiled many emerging economies that are saddled with large dollar-denominated debts and disproportionately depend on short-term capital flows that can evaporate quickly when sentiment shifts. As the dollar strengthens against local currencies, repayment of foreign-denominated debt becomes a far more difficult task.
That is the primary driver of concerns over the creditworthiness of Argentina — one of the biggest dollar borrowers in the developed world. While some analysts believe the dollar’s resurgence has run its course, many investors are not yet ready to wade back in.
Graham Stock, head of emerging markets sovereign research at BlueBay Asset Management, wants more clarity from the IMF about the credibility of Argentina’s fiscal adjustment and how lenient the fund will be on the targets laid out in the original bailout package before he dives back into Argentina.
Nicolás Dujovne, Argentina’s finance minister, hinted a fortnight ago that a revised deal with the IMF could come this month. This would clarify how much of the remaining bailout package will be front-loaded and address some of the skepticism expressed by managers such as Stock.
Assuming the government is able to achieve the difficult task of slashing the primary fiscal deficit a year earlier than its original 2020 timeframe, Bank of America Merrill Lynch estimates that without an early release of IMF funds, Argentina has financing needs next year of $23 billion. If the country rolls over 60 percent of its short-term debt during that period, the funding gap widens to $10 billion.
BlueBay’s Stock also worries about next year’s presidential election, given the harsher austerity measures Argentine President Mauricio Macri announced. “Previous attempts of fiscal adjustment have faced stiff opposition on the streets,” says Stock. “This program is more aggressive and the burden will fall on public sector workers and exporters.”
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