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Takeaway: We remain the bears on the Argentine peso and continue to see heightened risk of yet another Argentine sovereign debt default.

  • Argentina faces threat of expulsion from the IMF: The Argentine peso, which is down -20.6% since we outlined our bearish bias back on 11/4/10, continues to get Cristina Fernandez’d. If Argentina does become the first country permanently expelled from the IMF as indicated by the recent censure, we would expect to see Argentine sovereign debt default risk accelerate with the loss of at least $3.2B in emergency aid. This is something already being priced into CDS markets: the 5Y tenor is up +933bps/+66.4% MoM to 2,338bps wide.
  • Because of phony inflation statistics (USA?): What would turn the aforementioned censure into a full-fledged expulsion is a failure to appropriately address INDEC’s official CPI calculation, which has been under intense scrutiny for consistently underreporting inflation since 2007. For example, 2012’s “official” +10% YoY CPI reading compares with the estimates of leading private sector economists – many of whom having absorbed substantial fines – in the area code of +26% YoY.
  • Argentine gov’t vs. the market: This serial underreporting of inflation has cost holders of the country’s inflation-linked bonds ~$6.8B over the past 5yrs. On a 2yr basis, Argentine inflation-linked notes are down -31% vs. a +25% gain for Brazilian linkers and a +27% gain for Mexican linkers. There exists an opportunity for material upside in these illiquid securities if Argentina gets its act together under intense international pressure, but betting on a sane response from Cristina Fernandez is like betting on a Chicago Cubs World Series pennant – possible, but don’t hold your breath!
  • Another sovereign debt default on the horizon?: Absent a complete reversal of Argentine fiscal and monetary policy, continue to see heightened risk of yet another Argentine sovereign debt default over the long-term TAIL. Key catalysts on that front include: 1) The 2/27 US court ruling that will determine if Argentina must pay $1.3B to holdouts from its 2005 and 2010 restructurings; and 2) Continued popping of Bubble #3 (i.e. commodities, which should continue to make lower-highs as an asset class over the TREND and TAIL durations). The CRB Index remains bearish TAIL from a quantitative perspective.
  • Commodity deflation is a key catalyst: Regarding point #2 above, it’s important to note that investors in commodities hedge funds redeemed over 20% of their capital last year following the worst annual industry performance in over a decade (-3.7% in 2012 vs. -1.4% in 2011). We expect to see continued pressure on commodities as an asset class over the long term as investors who have failed to heed our warnings should continue to carry on varying degrees of forced sales amid redemptions. As we highlighted in our APR ’12 note titled, “ARGENTINA, IMPLODING”, what’s bad for commodities is really is really bad for the Argentine economy and its fiscal health.
  • Unsound fiscal policy ramps risk: Specifically, the central government has been relying on international reserves to service international debt since 2010 ($20B to-date and another planned $8B in 2013 as the gov’t ramps up spending ahead of OCT’s mid-term elections). With the EM universe’s highest interest rates of ~13%, this payment strategy has left Argentina with int’l reserves of only $42.6B, down -19% from a JAN ’11 high of $52.6B. USD-denominated deposits at Argentine banks have fallen to a 4yr low of $7.7B – down roughly 50% since Fernandez’s reelection in OCT ’11.
  • The Fernandez administration fears capital flight: To stem the tide of capital flight and preserve these now-sacred reserves, the Fernandez regime has nationalized corporate and pension fund entities (see: YPF saga), as well as implemented a series of incredibly punitive capital controls with some even resulting in imprisonment as a punishment for violation.
  • ...Which continues unabated: Argentinians – who ultimately fear a mass “pesofication” of their USD deposits and cash flow streams at the official USD/ARS exchange rate – continue to find clever ways to help their hard-earned capital escape the clutches of Fernandez & Co. The unofficial “blue-chip” swap rate (i.e. obtaining and selling USD-denominated securities for access to USD) has dropped -39% YoY to 7.6948 per USD; that decline compares to a far more modest -13.1% YoY depreciation of the official exchange rate.
  • Don’t fight the tape: It’s also worth noting that 3M NDF contracts are pricing in an additional -6.7% of declines and the 1Y contracts are pricing in an additional -26.6% of further downside from the latest spot price.
  • What to do from here?: Stay long the dollar-peso rate (i.e. short the ARS). For as long as Cristina Fernandez is running the show in Argentina, this should remain a high-conviction investment thesis.

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Darius Dale

Senior Analyst