Volatility returns to markets as election jitters take their toll

Argentine markets had finally seemed to find their footing, stabilising after months of turmoil had sent the peso tumbling and borrowing costs soaring. But the past few days show investor angst is coming back.

The concern that has contributed to peso becoming the world’s worst currency and undermined bond returns stems from speculation that next month’s crucial PASO primary vote may show strong support for opposition candidates ahead of October’s presidential ballot.

Investors are hardly thrilled with the performance of President Mauricio Macri since he took over December 2015, but the prospect of the business-friendly centre-right candidate losing re-election has them terrified. The fear is a return to the policies of the previous administration, when then-president Cristina Fernández de Kirchner imposed currency controls, intervened heavily in the economy and frequently feuded with investors at the expense of growth and business confidence.

There’s no outright panic at this point. Investors expect the primary vote – which is compulsory for Argentines – will show Fernández de Kirchner’s coalition with a small edge over Macri’s, though one that could easily be overcome after the number of candidates from smaller parties is whittled down. But money managers are starting to turn defensive in case results signal a bigger-thanexpected advantage for Alberto Fernández, the presidential candidate heading the Frente de Todos ticket.

“Investors might just take profits prior to the primaries,” said Edwin Gutierrez, the Londonbased head of emerging-market sovereign debt at Aberdeen Asset Management. “They have made good money on the trade, and liquidity is going to get worse as we get closer to the real elections.”

While Argentina’s overseas bonds edged higher Friday, holders had lost 2.5 percent over the past five days even as most notes from developing countries advanced, according to data from JPMorgan Chase & Co. The peso dropped 2.2 percent in that span, making it the worst performing emerging-market currency tracked by Bloomberg.

LEVEL OF SUPPORT

The major political coalitions have already picked their candidates for the presidential vote, but which party primary voters choose to participate in will give an idea of the level of support they can expect.

For the August 11 primary, Fernández is favoured over Macri for the overall vote tally, but a lead of five percentage points or more would be taken as a negative sign by investors, according to Carolina Gialdi, a senior fixed-income strategist at BTG Pactual Argentina in Buenos Aires.

Further complicating the picture is that investor access to reliable polling data has been limited this year as more local firms choose to restrict access.

Investors “may have been overly optimistic” before recently re-evaluating their stances, Gialdi said in an interview. After stock returns that exceeded 30 percent this year and the world’s best carry trade, it might make sense to lock in profits.

The risks are a policy reversal which at its most extreme could even raise the prospect of a debt restructuring in the next two to three years, according to Moody’s Investors Service. While that’s a worst-case scenaPRESIDENCIA DE LA NACION rio, Argentina is still vulnerable after getting a US$56-billion loan from the International Monetary Fund last year in an effort to stabilise government finances and boost investor confidence.

Macri’s re-election bid may be aided by signs of improving economic data and his success at stabilising the currency earlier this year after the peso lost about half its value in 2018. Inflation cooled for a third straight month in June, and the economy grew 2.6 percent in May thanks to a boost from the harvest, according to data published Thursday. It’s the second consecutive monthly increase and supports the IMF’s view that Argentina likely came out of recession in the second quarter.

IMPROVING IMAGE

The president’s image is also climbing ahead of the vote. A July poll by local consulting firm Elypsis – the only one to predict in 2015 that the elections would be pushed to a run-off round – found a gain in his voter support brought him to a statistical dead heat with Alberto Fernández in the elections’ first round on October 27. More than three-quarters of voters are split between the two frontrunners, illustrating the degree of polarisation.

For those willing to stomach the risk, valuations remain attractive in peso assets as policy continuity should lead to even more tightening in peso bond spreads, according to Morgan Stanley analysts. They recommended floating-rate bonds for “conservative bulls.”

The peso “could continue in a virtuous circle as long as the global backdrop remains as supportive as now for high-carry currencies,” strategists led by James Lord wrote in a note Thursday. “Markets should feel more comfortable.”

But after the carry trade – buying Argentine peso-denominated bonds with borrowed dollars – returned 14 percent this year, the most among major emerging markets, lots of investors seem to think now may be time to take a step back.

“Having enjoyed a very strong performance and facing increased political risk as we approach the primaries, it seems reasonable for investors to take some profits at these levels,” BBVA analysts led by William Snead wrote in a note.