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Facing the
underlying risks of gradualism. Recent
global market turbulences have exacerbated the negative effects of
the unforced errors that the government has been making since
December, stressing the local market and leading the authorities to
seek IMF assistance. Confronted with the risks embedded in its
gradual strategy, the government chose to stabilize local markets
despite knowingly facing a significant political cost. And the
international support to the chosen policy path was extraordinary,
with an agreement that demands an extra fiscal effort and
strengthens monetary policy, while it also allows the government to
remain out of global debt markets for some time. More than ever,
authorities have confirmed their understanding of the importance of
fiscal consolidation, standing up to their word when they promised
to accelerate fiscal adjustment in case the context demanded it.
Overall, we are now facing a more robust policy path, though at a
significant political cost.
Sailing
against the tide. The economy grew at a very fast
pace in 1Q18, though it is now going through a recession. The
toughest drought in decades was then combined with a severe flood,
monetary policy became gradually restrictive despite lagging
expectations, fiscal policy should continue to harden, real incomes
are being eroded by inflation ac-celeration and the recent
volatility spike was a final blow to confidence that may well
challenge a solid investment demand. Against this backdrop, the IMF
agreement significantly reduces risks and creates the conditions
for the recession to be short lived. So, as long as the government
manages to stabilize expectations, the reversal of some transitory
factors and an improvement in most economic indicators could lead
to an activity rebound as soon as 4Q18 and better economic
performance during next year.
A revamped
monetary policy framework. Federico Sturzenegger’s
resignation to the BCRA, and the appointment of Luis Caputo as the
new Governor, presents a unique opportunity to revamp a monetary policy
framework that could well use an extra dose of credibility. This
time, the new inflation targets are much better aligned with the
rest of the economic policy, while some aspects of the IMF
agreement significantly increase BCRA’s firepower. Even as the
first policy changes proved effective, inflation continues to be
challenging and credibility rebuilding will likely take time and be
costly.
Fiscal
consolidation accelerates, with financing risks off the horizon. Fiscal
improvement since early 2017 has been probably the best policy
achievement so far, and it is even picking up further pace. The
primary deficit fell 71.3% y/y in May, reaching a cumulative 3.0%
of GDP in the trailing 12 months that leaves the government very
well positioned ahead of this year’s 2.7% target. Expecting an
over-achievement of this goal, as long as the economic slowdown
does not significantly hurt revenues the government could even
have some extra room to pay 2019 expenses in advance, easing next
year’s fiscal effort. In the meantime, the IMF agreement means the
government would not need to return to debt markets at least until
next year. Still, further structural reforms will be key to resume
spread compression, especially in a global context that promises to
turn even more challenging.
And the
suggested trades are... The government’s
conviction to continue moving forward with deficit reduction and
its anti-inflationary commitment were under siege. In this respect,
seeking IMF assistance seems a healthy choice and guarantees the
sustainability of the chosen policy path. This, combined with some
positive moves from the government and an opposition with no
favorable policy results in the past and lacking alternative
leadership, are our main reasons to expect a change in current trends.
Still awaiting further signs of stabilization despite recent
changes, we believe it is not yet time to increase risk exposure.
Among sovereign hard currency bonds, we rather receive the short
end of the curve and strongly believing duration should not exceed
DICY in the belly. Awaiting increased peso stability before
increasing duration in local currency, we consider short term
Lebacs offer the best risk-return profile, while the short end of
the CER curve (AF19) also remains attractive. Finally, the upgrade
to Emerging Market status by MSCI should provide some oxygen and
renew convictions for equity investors, favoring companies with
ADRs that would make it into the indices. We favor GGAL among
banks, YPF and PAM as attractive bets in the energy sector and CEPU
and TGS among utilities.
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