Weekly Latin America Risk Monitor: Argentina’s Making Noise

Conclusion: Our dominant TREND-duration themes remain largely intact throughout the region from a high-frequency data perspective. In the context of this “quiet” week, we’ve interpreted recent market signals as an opportunity to look under the hood of Argentine policymaking – specifically with regards to a potential currency devaluation.

 

PRICE SIGNALS

  • EQUITIES Median: +1% wk/wk; High: Argentina +10.3% wk/wk; Low: Mexico -0.5% wk/wk; Callout: Argentina +15% YTD;
  • FX Median: +0.5% wk/wk vs. USD; High: Colombian peso +2.6% wk/wk; Low: Argentine peso -0.1% wk/wk; Callout: Mexican peso -10.5% YoY;
  • S/T SOVEREIGN DEBT (2yr) High: Brazil +8bps wk/wk; Low: Colombia flat wk/wk; Callout: Brazil -30bps in three months;
  • L/T SOVEREIGN DEBT (9-10yr) High: Brazil +25bps wk/wk; Low: Mexico/Colombia -7bps wk/wk; Callout: Mexico -56bps in six months;
  • SOVEREIGN YIELD CURVE High: Brazil +17bps wk/wk; Low: Mexico -9bps wk/wk; Callout: Mexico -23bps in one month;
  • 5YR CDS Median: -0.3% wk/wk; High: Peru +3.4%/+6bps wk/wk; Low: Argentina -3.6%/-34bps wk/wk; Callout: Peru +15.5%/+24bps in one month;
  • 1YR O/S RATE SWAPS Median: +0.8% wk/wk; High: Chile +5%/+22bps wk/wk; Low: Brazil -0.2%/-2bps wk/wk; Callout: Colombia +3%/+15bps in six months;
  • O/N INTERBANK RATES Median: -0.4% wk/wk; High: Chile +0.4%/+2bps wk/wk; Low: Mexico -0.7%/-3bps wk/wk; Callout: Argentina -13.7%/-160bps in two months;
  • CORRELATION RISK The MSCI Latin America Equity Index has gone from -67% correlated to the U.S. Dollar Index on a six-month basis to +24% correlated on a three-week basis.

Full performance tables can be found at the conclusion of this note.

 

CHARTS OF THE WEEK

With the potential for a peso devaluation in 2012, Argentine monetary policy remains a key risk factor in the region.

 

Financial repression has been supportive of peso deposit growth and lower ARS deposit rates:

 

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The issue (capital flight ahead of a pending devaluation) which necessitated the latest round(s) of Big Government Intervention, while less dire on the margin, remains:

 

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This is due to the likelihood that the peso may be devalued by over 20% in order to meet a 2012 dollar debt service payment using “free-and-available” FX reserves:

 

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KEY CALLOUTS

Growth Slowing’s Bottom:

  • Brazil: Manufacturing PMI accelerated in DEC to 49.1 vs. 48.7 prior.

Growth Slowing:

  • Brazil: Export growth slowed in DEC to +5.8% YoY vs. +23.1% prior. Trade Balance growth slowed in DEC to -$1.5B YoY vs. +$291M prior. Industrial Production growth slowed in NOV to -2.5% YoY vs. -2.2% prior.
  • Mexico: Global Economic Indicator (proxy for GDP) slowed in OCT to +3.7% YoY vs. +4.6% prior.
  • Mexico: Both Manufacturing and Services PMI readings slowed in DEC to 52 (from 53.5) and 54.1 (from 54.4), respectively.

Deflating the Inflation II:

  • Brazil: CPI slowed in DEC to +6.5% YoY vs. +6.6% prior, allowing the central bank to avoid breaching the upside of its FY11 inflation target (+4.5% +/- 200bps). At +6.5% for the whole of 2011, Brazil just closed out its fastest year of price increases since 2004. Our models do point to further downside in 1H12, however, as does the market. Brazil’s 2013 breakeven rate has fallen -70bps to 5.75% since peaking on SEP 21.
  • Colombia: CPI and PPI slowed in DEC to +3.7% YoY (from +4%) and +5.2% YoY (from +6.8%), respectively.

King Dollar:

  • Mexico: The peso, which is down nearly -15% vs. the USD over the last six months, is contributing to an increase in Mexican CPI alongside a domestic drought (via lower food supplies). CPI accelerated in DEC to +3.8% YoY vs. +3.5% prior, the fastest rate in 12 months.
  • Argentina: As a result of financial repression via capital controls and new FX regulations designed to stem record capital flight ($18B through 3Q11), Argentina’s peso-denominated time deposits are growing at a record pace (+4.7% MoM) as domestic savers are robbed of alternatives to store their wealth. Additionally, the central bank is building FX reserves at a record pace (+$2.5B MoM in DEC). The build-up/reversal of declines has been supportive of sovereign dollar debt (2017 yields down -313bps since OCT 4 to 9.54%; Argentine dollar debt up +3.3% YTD after being the worst EM sovereign performer in 2011) as the country plans to tap its FX reserves to make a +$5.7B debt service payment next year. Per Argentine rule (always subject to whimsical change), the government can only tap “free-and-available reserves” in excess of the monetary base and current calculations leave the government with a -$5.4B deficit. To get to a +$5.7B surplus, the peso needs to be devalued by -24% assuming a constant monetary base. USD/ARS forward markets are pricing in a -16.7% devaluation in the coming year, up from a trough of -25.9% in early NOV.

Counterpoints:

  • Chile: Economic Activity Index (proxy for GDP) accelerated in NOV to +4% YoY vs. +3.4% prior. CPI also accelerated in DEC to +4.4% YoY vs. +3.9% prior.

Other:

  • Brazil: The government’s aggressive capital controls proved successful (relative to their stated objectives) in 2011. Foreign investment flows increased +168% YoY to $65.3B – with roughly 92% of that being the preferred FDI.
  • Mexico: The sell-side is bullish on the peso, forecasting at ~5% gain through June on the heels of a -25% reduction in the number of economists predicting a Banxico rate cut per their latest survey.
  • Argentina: Mark Mobius, Head of $45B Templeton Emerging Markets Group, is bullish on Argentine equities. “Although the political environment is not very good, the companies are very cheap so we’re looking closely… We continue to add selectively as more money comes into the fund.” The threat of a big bid like this in such an illiquid market has forced intense short covering in the Merval Index (up +15% YTD).
  • Argentina: Tax revenue grew +31.8% YoY to ARS540B in 2011; when coupled with public-sector salary increases > +20% earlier in the year, it’s easy to believe private economist estimates of inflation running north of +20-25% YoY vs. official statistics of +9-10%.

Darius Dale

Senior Analyst

 

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