Argentina: bottoming out?
Just two months ago, almost everything appeared to be going sideways in Argentina.
Following poll results that showed a path to victory for former leftist president Cristina Fernández de Kirchner, turbulence once again gripped Argentine assets. The peso plummeted against the dollar and yields on the country's government debt spiked alongside the cost to insure against an Argentina debt default. And inflation? It continued its relentless march higher.
While many, many risks remain, Argentina's near-term prospects now look a bit brighter not just politically, but also economically.
On the political front, the return of Ms Fernández to the presidency is no longer the threat it used to be. Yes, she could still be vice-president if her running mate and former cabinet chief Alberto Fernández wins the top slot, but as second fiddle, there's hope (some would say wishful thinking) that her more controversial impulses will be constrained.
And although polls remain neck-and-neck, incumbent Mauricio Macri's re-election chances have also improved with the selection of his running mate, Peronist Senator Miguel Ángel Pichetto. This thinking goes that by shifting to the political centre and choosing someone from his opposition party, Macri will broaden his electoral appeal — a necessity if he is to reverse his slumping popularity.
These political developments have helped to bring about some calm to the country's currency — the peso is among the best performing EM currencies in recent weeks — at a time when inflation finally looks to be nearing a tipping point. While consumer prices did rise 3.1 per cent month-over-month in May and annual inflation ticked higher to 57.3 per cent, the monthly rate of change is lower than April's 3.4 per cent. Carlos de Sousa at Oxford Economics expects this slide to continue, with annual inflation settling around 38 per cent by year-end.
Ironically, it's the peso's current stability that has led De Sousa to revise up his inflation target by three percentage points, as the above chart shows. Here's why:
A calmer exchange rate means the central bank will not intervene in the FX market as much as we had anticipated, leading to faster growth in the monetary aggregates, which are among the main causal variables of inflation.
Still, annual inflation of 38 per cent is a substantial improvement from today's levels and, although higher than previous forecasts, portends a stable peso which is one of the most crucial conditions for Macri to hold on to his presidency.
When it comes to Argentina's industrial sector, a modest turn-around is under way there as well. As Alberto Ramos of Goldman Sachs points out in a recent note, after four consecutive months of declinining growth -- averaging -2.6 per cent quarter-over-quarter--- the industrial sector grew 0.6 per cent last month. The move came despite a 1.7 per cent quarter-over-quarter decline in utilities. Manufacturing and construction growth more than made up the difference.
Another sign for Ramos that the economy has reached a cyclical bottom is that while real GDP declined substantially along with consumption and investment spending in the first quarter, the pace of that GDP contraction was slower than in the past. With this de-acceleration, Ramos reckons the real business cycle will stabilise in the second quarter and recover during the latter half of the year — bolstered by improving agricultural and energy output, alongside exports.
The current external environment helps as well. According to Sebastian Rondeau at Bank of America, three shifts have occurred recently to Argentina's benefit. The first is the fact that the Fed, and other central banks, have turned more dovish. With Chair Powell saying this week that the Fed will "act as appropriate to sustain the expansion," investors believe a interest rate cut next month is all but guaranteed. This more accommodative backdrop, reinforced by the ECB, is critical for a country like Argentina, which has large financing needs just around the corner.
The second positive development is what's going on with commodity prices, namely soyabeans. As Argentina's most important export product, soyabeans' 14 per cent recovery since last month's lows have helped to shore up the economy. And according to S&P Global, the forecast for the country's soyabean production is the second-highest in 19 years, up 48 per cent year-on-year following 2018's dismal harvest.
Finally, Brazil. Argentina's economic fate is intimately intertwined with that of its neighbour thanks to the strong trade ties between the two countries. Rondeau points out that Brazil's currency appreciated 6.2 per cent against the dollar since May 20, a boon for the peso.
This close connection could soon turn out to be a problem however, given how much Brazil's outlook has darkened since the election of populist president Jair Bolsonaro in January. In the three months following his inauguration, the economy shrunk — the first time since 2016. Recession fears are mounting, but some analysts and investors are holding out hope that pension reformm and an increasingly dovish central bankm will stem further contraction.
All in all, the the situation remains perilous in Argentina: with the polls running close election risks linger and, despite the improvement, the economy is still teetering on the edge. Between now and October, in other words, there is still plenty of time for volatility to return with a vengence.
So until then investors, enjoy the respite.