Dear ArgenGrowther,

Politics doing its thing to show the government what Argentina is. In an endless push and pull, politics sets the pace for a bleeding Argentina. The skyrocketing country risk, the BCRA no longer buying as it used to, and an industrial production trying to grow marked the week's data.

Financial ArgenGuide:

Data:

• MEP Dollar: 1.312; -9.08%

• Country Risk: 1.582; +20.58%

• AL30: 51.35; -9.26%

• BCRA:

  • Foreign exchange USD +99 million.

  • Reserves USD +634 million; today, USD 29,297 million.

• May 2024 Revenue: 13,379,446 million; +320.9% year-on-year; real +10.8%.

  • VAT: 3.097.295 M; +204.2%

  • PAIS Tax: 563.100 M; +1,239%

  • Income Tax: 5.511.952 M; +585.8%

  • April Industrial Production Index (IPI) Manufacturing: monthly +1.8%; year-on-year -16.6%

Now, what does all this mean?

Positive or negative? Spoiler alert: negative and gritting teeth, the furious red showed the government this week that you can't live on expectations. Financials adjusting to reality?

Dollar and Strong Peso. We seem to have returned to the old normal in the last few weeks, and volatility is here to stay.

Less stability = Less predictability

Less predictability = Worsening economic expectation.

There was a lot of movement here during a complex week that started with a similar dynamic to the previous auction, where the surplus pesos seemed to have partly gone to dollars. Still, we saw that volatility extended to other assets, so the feeling is that other factors are behind it. What could those other factors be? The government's silence on the swap with China doesn't help, and what was already anticipated at the beginning of the week with the vote in Congress seems to have added fuel to the ever-burning dollar fire in Argentina. For now, the blaze is not alarming; there's still the feeling that there are no reasons for this to escalate and as we said last week, it has no oxygen, recession and the lack of pesos (monetary base contraction) naturally extinguish the fire and put a cap on the dollar's rise.

Recession = Less pressure on the exchange rate

Monetary base contraction = Less pressure on the exchange rate

In recent weeks, there has been a decline in the volume traded in the free exchange market, which, combined with the dynamics of lower purchases by the BCRA and volatility, pushed up the implicit rates of dollar futures after a sustained decline since the beginning of this government. They seemed to have made a first floor in early May, moving from 3%/3.5% to above 4.5% for August contracts and beyond. For now, the government seems firm that the 2% crawling peg is untouchable.

Higher implicit rates in futures = Higher devaluation expectations

Recomposition of Public Accounts. Some good news from the real side is that revenue recorded its first real year-on-year increase since the government change. At the same time, the Central Bank continues its balance sheet cleanup process.

Revenue. Income Tax is the primary explanation for the real increase, given the December 2023 tax returns deadline, and devaluation explains the significant difference from the previous year, which was already expected. To put it in perspective, its share represented more than 40%, something not seen in 20 years.

We continue with the PAIS tax monster rising 250% year-on-year, while Income Tax rose 80% and export duties 11%. Now, when we look at VAT, it reflects the recession we are immersed in, the leading tax associated with consumption with a year-on-year drop of 22%. Another significant economic activity indicator, the check tax, fell 25% in real terms in May, representing the most significant drop in 20 years, surpassing the pandemic collapse. If we use the tax as an early indicator of economic activity, we will see another economic activity collapse in May's numbers.

Lower VAT collection = Less consumption

Lower check tax collection = Less economic activity

BCRA. On the way to destroying remunerated liabilities but accumulating fewer reserves than expected?

Remunerated Liabilities. We've been saying that pesos are migrating from BCRA to Treasury in each new auction, reducing remunerated liabilities, already at almost 20-year lows in real terms, on the way to their disappearance. This number will probably continue to fall again this week, and we will see it decreasing fortnightly according to the Treasury's auction schedule.

Fewer remunerated liabilities = Less monetary issuance

Fewer dollar purchases = Less monetary issuance

Less monetary issuance = Less inflation

We mentioned that the constant migration of pesos from BCRA to the Treasury aims to clean up the BCRA's balance sheet and, as a transparent counterpart, increase Treasury debt. Is the government seeking to strengthen the BCRA to pave the way for lifting the exchange controls? According to the government's communications, this seems to be the case, but liabilities are only part of the equation.

Rates. After the last (surprising) rate cut, the dynamics of Lecaps and the dollar changed. The Central's maneuver seems to have had its first misstep with hindsight, as we saw a sharp increase in volatility, and the market now expects the government to do (or say) something. Will there be a new steering move to readjust?

Debt. Much has been said about transferring BCRA debt to the Treasury and the associated tensions. However, it's important to highlight a very strong caveat that the government has had concerning short-term maturities: the Treasury's account at the BCRA. What are we talking about? As we saw in the last auctions, the Treasury took much more pesos than needed; in some cases, those pesos were used to repurchase dollar debt, in others dollars for future debt payments, but there's also the account the Treasury holds at the BCRA. According to the government, this account's primary purpose is to provide a short-term safety cushion. Let's go with numbers to exemplify and clarify:

The Treasury has peso maturities in June and July amounting to USD 16.974 million; it seems like a lot, right? Considering that the Treasury account at the BCRA holds $13.5 trillion, the number doesn't seem that high. Although we mix dollars and pesos, the fact is that the government has a solid cushion to meet peso maturities. But this cushion is a cushion; the government has been renewing peso debt without problems, ending each auction with positive net financing (taking more debt than it had), so we can assume that this cushion aims to meet obligations if the outlook worsens.

Regardless of the cushion, the peso curve must be healthy, and maturities should not be a biweekly mountain to relieve short-term pressure and extend maturities as much as possible to provide more long-term stability.

Substantial rise in country risk this week worsens expectations. As we have been saying, lowering country risk is one of the key aspects for the country to move forward and meet its heavy payment commitments in the coming years. The logical (not abundant when it comes to Argentina) thing would be for the country to refinance this debt in the coming years and "kick it forward," given that the maturities are more constrained and not as heavy. As we approach 2025 and the payment commitments get closer, this will probably become more relevant week by week.

Higher Country Risk = Higher bond interest rates

Higher bond interest rates = More expensive financing

Economic Activity. Some positive numbers are starting to confirm month-to-month. Well, can it only go up at the bottom of the pit?

Economic Recovery. The seasonally adjusted monthly data shows a slight rebound for industrial production +1.7% and construction +1.8%. Let's not look at the year-on-year numbers to forget for a moment the brutal recession we live in, -16.6% and -37.2%, respectively.

The Street. Wages are recovering against inflation, and that's great news for the government; the street is beginning to regain purchasing power. The RIPTE recorded its second consecutive real increase of 6.7% in April, and again, not looking at year-on-year -20.1% (shows the severity of the current moment). Remember, there are various methodologies, and the RIPTE doesn't account for non-remunerative items, but wages have already seen their floor.

The recovery of wages is crucial as a thermometer of society and endurance capacity. If we have seen the floor, does it mean the worst is over, and people continue supporting the government despite everything? The sharp drop in inflation undoubtedly contributes significantly to these aspects.

Lower Rate = Greater incentive to take credit

Greater incentive to take credit = More credit?

More credit = More economic activity

Inflation. Section soon to disappear. The Autonomous City of Buenos Aires data showed a CPI of 4.4% for May, and the REM expects 5.2% for May, then stabilizes around 5% (remember, the REM has been overestimating inflation since the government change).

Capital Markets - Actionables

Brutal week. Movements all around that force us to stay alert. Volatility came to bathe Argentina with a reality check once again. A sharp decline in almost all assets, where did the pesos go, is the question? Decline in stocks, dollar bonds, peso bonds, barely a rise in the dollar concerning the overall drop makes us wonder what's happening with the pesos and where they are going?

The worst week for the current government in terms of Argentine assets, there was no refuge. For those in the long run, the basics seem unchanged. Suppose we are invested in Argentine assets (for investors who can tolerate and bear the risk). In that case, the volatility with which we can get that extraordinary return is part of the game.

Stocks returned to values of a few weeks ago; although the drop was significant, the previous rise was too. Buckle up; the country's movement speed is not for everyone.

The counterpart of the Lecaps drop is that they increased the rate they pay and regained some attractiveness concerning expected inflation and devaluation. For those needing to be in pesos, there is a higher yield today in Lecaps, especially measured against T+0 money market mutual funds.

Sovereign bonds suffered heavily this week after a significant rally and lateralization in recent weeks, presenting extraordinary yield opportunities at these levels and returning the entire invested capital within this government's term. If paid according to schedule, the Bonares 29 and 30 (AL29 and AL30) will return all invested capital during Milei's term, which repeatedly asserts that commitments are strictly fulfilled.

Rate rise = Price drop

We continue to affirm that as long as the government continues to show good numbers, the country's risk decline will eventually resume, and the hard-dollar bond rates will keep compressing.

Brief Reflection

We've been wondering if Argentina can work as a team to get the country forward and if the legislative power would be up to the task. The legislative responds by raising their salaries and rejecting the elimination of privileged pensions. Are they out of touch with the people? At the same time, the Chamber of Deputies gave half sanction (in a show of unified opposition power, UxP and UCR) to a project to modify the pension mobility formula, estimated to have a fiscal impact of 0.45% of GDP. This goes against the executive's precise path, with the budgetary surplus anchor as a government program. We saw how this apparent setback to the executive's plans had transversal impacts on the financial world. Clearly, it was a negative week for the government in the political arena.

These political noises, coupled with speculations about the renewal of the USD 5 billion swap with China and the government's silence on this matter, led to a severe blow to expectations of whether we can indeed climb out of the hole we are in. Although the money to repay the swap is there and to meet upcoming dollar debt payments as well, this would add pressure to very weakened international reserves.

Local idiosyncrasies are already complex, and we have to add an international context that hasn't been helping with the US 10-year rate rising (and with volatility), coupled with emerging currencies like the Mexican peso and the Brazilian real, which experienced a sharp devaluation in recent days unseen for years. Perhaps the European Central Bank (ECB) will help with a rate cut after five years, from 4% to 3.75%.

A global interest rate cut cycle would be great news for Argentina, which will probably need to refinance its debt shortly.

Last week, the legislative answered whether they would be up to the task one way, and today, we have an answer for the other. What will be confirmed in the coming weeks? Will we finally have a favorable sanction of the Ley Bases on Wednesday? Are we heading towards a country where politicians represent the population and act according to what Argentina needs? Will the judges be up to the task and adjust to a liberal Argentina? The three powers acting in the same direction will be a fundamental pillar to show the world that Argentina has changed.

Argentina needs a highway to do business, not a road full of potholes; are we getting closer? Today, it seems not."

See you next week, Vamos Argentina!

Nau Bernués
Founder, ArgenGrowth

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