Jennifer James, portfolio manager within the Global Bonds Team, discusses the fallout from the shock primary election results in Argentina in August, exploring what this might mean for Argentina’s asset markets and other emerging economies.
Following the unexpected results from the primaries that were released on 11 August, Argentina is now in a state of flux. Asset prices have significantly devalued, reflecting both uncertainty and a lack of market liquidity given the summer holidays. It is too early to know what the outcome will be, but the market’s reaction so far reflects the worst possible scenario – default.
Although the presidential elections are not until the end of October, the market has assumed an Alberto Fernández win. Most polls had him in the lead, with anywhere from a 1- to 8-point margin over the incumbent, Mauricio Macri. Instead, the actual results showed a 15-point difference. A Macri win in October is highly unlikely given this gap. However, Macri does look poised to put up a good fight – Bloomberg is reporting that he will be announcing new measures to increase social spending. Measures contemplated include boosting childcare benefits, providing tax exemptions for lower income earners, increasing the minimum wage, and containing fuel prices, among other things. These actions should help to alleviate some consumer unease in a country where inflation is around 50%.
How might the IMF react?
Separately, all eyes are also on the current US$56 billion International Monetary Fund (IMF) package, the largest ever from the IMF. In July, the IMF approved the latest disbursement of US$5.4 billion. Notwithstanding the timing of the elections, there is additional uncertainty from the IMF side. The package was negotiated under then IMF President Christine Lagarde, who has since been named the President of the European Central Bank (taking over after Draghi’s term comes to an end on 31 October 2019). By all accounts, she had a warm and constructive relationship with Macri. It remains to be seen if the new administration and new IMF leadership will have a similar relationship. The impact for Argentina could be dire if this funding were to be restructured or removed.
Fallout and contagion
In the meantime, markets have priced a high probability of default, with recovery values of the sovereign bonds in the high-50’s (ie, around 50% of par value). Equity markets collapsed, with the MERVAL Index falling 50% in US dollar terms in one day (12 August 2019). JPMorgan, the investment bank, estimates that most debt investors were overweight Argentina: the Financial Times reported that many bond funds suffered large losses this week on the back of this positioning. All of this hints at the continued poor technicals once market liquidity does improve in September. The best case scenario is that we see a Fernández administration that is pragmatic and less populist in its economic policies than the campaign rhetoric would imply. Although Fernández has ruled out a debt ‚default‘, he has hinted at a debt restructuring; note that for credit purposes, a restructuring and a default are synonymous. In the coming weeks, we expect him to crystallise his economic policies and these could provide opportunities for risk assets to recover, or continue trading off.
As of now, the outcome is unknowable, and therefore it makes sense to do nothing in the Argentina space until we get more clarity on fiscal policies. Outside of Argentina, its biggest trading partner is Brazil and that economy has its own issues with anaemic growth despite the expected success of a lauded pension reform package. We continue to see stresses across emerging markets, with political uncertainty in places such as Turkey, Hong Kong/China, and India/Pakistan, and economic weakness in countries such as Mexico, China, and South Africa. Contagion from Argentina has been widespread in bond markets this week, exacerbated by seasonal market illiquidity; this has put pressure on risk assets across the board as investors question tenuous growth expectations. We remain cautious.