Shift by Argentina’s central bank rings alarm bells
When Mauricio Macri was asked at the World Economic Forum in Davos last week whether he had been putting pressure on the central bank to lower interest rates, he momentarily appeared to lose his cool.
Having breezily fielded varied questions in fluent English, Argentina’s president quickly switched into Spanish to make clear that its governor, Federico Sturzenegger, enjoyed “absolute independence” to manage monetary policy “as he sees fit”.
For investors, the question of central bank credibility and the consequences for the currency is a red-hot issue.
Foreigners have bought heavily into Argentina’s peso-denominated debt, only to see the peso become one of the world’s worst performing currencies so far this year — losing 5 per cent against the US dollar — at a time when most currencies are strengthening against the greenback.
The country’s fast-won status as a market darling after Mr Macri took power just over two years ago has been tempered by confusion over a shift in the central bank’s interest rate policy last week.
The bank’s decision to cut its policy interest rate by 75 basis points to 27.25 per cent on January 23 took many in the financial community by surprise as most believe it will struggle to hit even its new, relaxed inflation target this year of 15 per cent.
“Analysts don’t understand what the central bank is doing at all,” says Marcos Buscaglia, an economist in Buenos Aires, who points out that forecasts of policy moves have consistently been wide of the mark. “That’s odd . . . there is a communications problem.”
Alarm bells have been ringing for investors since the government relaxed the central bank’s inflation target in late December after market speculation of such a change triggered weakness in the peso that month.
After inflation reached 24.8 per cent in 2017, the move to tolerate a 15 per cent target — rather than a band of 8 per cent to 12 per cent — was seen as a response to widely-held concerns that high interest rates were stifling Argentina’s economic recovery.
“What the market wants is a reaffirmation that inflation is [the central bank’s] priority,” says Siobhan Morden, head of Latin America fixed income strategy at Nomura Securities International.
The blow to the central bank’s credibility marks a dramatic change from investors’ exuberant attitude towards Argentina less than a year ago when the government sold a heavily oversubscribed 100-year bond. Argentina’s stock market led global performance in 2017.
Concerns that a new era of currency volatility in Argentina beckons have taken the shine off the “carry trade”, which involves borrowing at lower interest rates in one currency to invest at higher rates in another.
“The peso has clearly been too strong,” says Diego Ferro, co-chief investment officer at Greylock Capital Management. “Interest rates remain high so the carry trade still makes some sense, but [the peso] is going to be more volatile,” he added, referring to one of the hottest trades in emerging markets last year.
While the Argentine carry trade may be in a mature phase — with foreigners holding almost $5bn of $61bn of the central bank paper that investors prefer for the trade — a mass exodus in the near term remains unlikely.
“That would be a huge risk for the central bank ... these things tend to be sudden, although it depends where the peso trades,” says Ms Morden, arguing that there is no motive for a sharp exit from the carry trade at the current exchange rate of almost 20 pesos to the dollar.
Certainly, discouraging foreign investors from the carry trade would be premature, she says. Given Argentina’s under-developed local capital markets, the government continues to rely on foreign investors to finance a gaping fiscal deficit without resorting to printing money.
Already this year, Argentina has issued $9bn in foreign debt, although prices of its dollar-denominated bonds have fallen more than 3 per cent since January 1. Worse, Chubut province’s bond prices momentarily collapsed last week after a gaffe by its governor, who unintentionally said the province would “restructure” rather than refinance its debt.
Even so, many remain confident that Argentina’s economic transformation under Mr Macri remains on track. Alberto Bernal, chief emerging markets strategist at XP Securities, even argued to clients that the peso would appreciate in real terms this year.
“It is quite probable that if the peso continues to lose value [against the dollar] in a drastic manner, the central bank’s board will utilise some of the existing ammunition to counter [exchange rate] volatility,” he wrote in a note.
For Daniel Melhem, managing partner at Knightsbridge Partners, an investment group in Buenos Aires, disagreements between officials over how economic policy should be managed is no cause for concern, especially after years of heavy-handed state intervention in the central bank. “When Sturzenegger leaves office, that’s when we have to be concerned — and not before.”