By: Andrew Brodbeck
In November 2016, I wrote about evolving foreign exchange (FX) opportunities in Argentina due to the significant structural reforms in the country. The new government has been focused on restoring credibility, and with this comes change in FX markets. Now, six months later, I would like the revisit the subject, assess recent events and identify key factors that may be important for hedgers to monitor going forward. I spoke with my colleague, Andres Etchegoyen, an FX and local rates trader with Cargill in Buenos Aires. Here are some highlights from our discussion.
Andrew: Andres, over the last six months, the Argentina reform story seems like it’s still on track. What are key indicators that help validate this is the case?
Andres: An important indicator of the new administration’s commitment to reform is the consumer price index. The central bank has set a new inflation targeting regime, and its monetary policy is consistent with the goal of sharply decreasing inflation. It appears that after four months of inflation over the target, May 2017 will be the month to show the beginning of a deceleration in prices. Another indicator to follow is the fiscal deficit. The development of responsible spending would demonstrate the ability of the country to repay its debt in the long term.
Andrew: Last month, Central Bank Chief Federico Sturzenegger, announced a goal to achieve international reserves of 15% of GDP – an increase from the current level of just 10%. How are risk managers thinking about this as a material event?
Andres: It is important for corporate hedgers to remember that emerging market currencies behave very differently from developed markets. The timing, size and scope of central bank intervention are important points to review before one can adequately understand the risks. In the case of Argentina, in order for the central bank to achieve its goal, it will need to be in the market purchasing U.S. dollars on a regular basis. This also can have inflationary implications that may require interest rate increases from already lofty levels. It is challenging to boost reserves while avoiding interest rate hikes that slow growth.
Andrew: As Argentina has returned to the global bond market, the country, provinces and corporates have found good demand from lenders. What is the impact on the Argentine Peso (ARS) and the offshore liquidity?
Andres: One of the key drivers of ARS is the local bond market. While corporations hedging risk in Argentina may not be closely following investor activity, it’s important to factor in their behaviors and potential triggers of inflows and outflows. The investment community could participate in a carry trade, whereby it sells U.S. dollars to fund local bond positions or own the ARS outright. The carry trade community is important because it is more short-term money, different from long-term bond holders that own bonds as part of a benchmark allocation. Bonds held for the longer term tend to be considered “sticky money”. One of the reasons that it has contributed to historically low hedge ratios, is the liquidity. As investors have come back to the market, daily trading volumes are increasing and the numbers of counterparties also have increased.
Andrew: What other indicators can we use to monitor FX sentiment in Argentina?
Andres: It’s important to keep an eye on the non-deliverable curve. The implied yields on the front end of the NDF curve can spike when there are investor concerns. There is no sign of this now, and steady corporate and province bond issuances suggest there is some appetite for local paper.
Andrew: In June, Argentina will hold primary elections followed by mid-terms in August. How should corporate hedgers and risk managers think about the impact on the FX market?
Andres: Political dynamics will play a part in the nervousness of the market, but it might be overstated. No candidates have formally been announced for mid-term elections yet, so it’s difficult to know who the parties are sending and which platform they’ll run on. We’ll know more about this in June of 2017, and then the elections are August 12, 2017. In reality, there will likely be no change in majority so the market doesn’t expect a material shift in the way it is working now. We might see volatility before and shortly after, but the bigger issue will be the focus on the 2019 elections once the mid-terms are done.
Andrew: Great. Thanks for sharing your perspective and we will be sure to keep in touch as this situation evolves.