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Argentina rocks the market

EM investors look to de-risk as the weekend’s events continue to play out.

Global equity markets were volatile last week with a steep sell-off early in the week as the US threatened further tariffs on China and labelled the country a currency manipulator.

On the data front, US ISM printed a very weak number and European PMIs also underwhelmed, adding to the growing malaise around the growth outlook.

In EM fixed income, local markets continued to underperform hard currency markets as the weaker global growth outlook weighs most heavily on FX markets, while core rates remain supportive of returns in hard currency.

Market review

  • The biggest EM news came in Argentina over the weekend where the Frente de Todos party (led by the Fernandez-Fernandez ticket) took an almost 15% lead and achieved 49% of the positive vote in the PASO. Peronist governors and mayors showed overwhelming support for the ticket, which led to a large gap opening up between Fernandez and the incumbent Macri, delivering a substantial shock compared to polls released just two days earlier as well as a significant blow to Macri’s chances of re-election in the actual vote in October.
  • The market reaction was severe given many investors had gone into the PASO with long positioning both in local and hard currency markets with the assumption that the incumbent (Macri) would ultimately win the election in a second-round run-off. The exchange rate weakened more than 20%, the local equity market traded down over 30% and hard currency sovereign bonds traded down by more than 20bps.
  • Given Argentina’s hard currency debt burden and its ongoing financing requirements, it needs to ensure investor confidence and this is severely lacking after the weekend’s political events. As we approach the October elections, it is unlikely that the new favourite, Fernandez, does much to appease markets. We believe it will be essential to watch the higher-frequency data, including local currency time deposits and FX deposits, along with international reserves.
  • Ultimately though, it is most likely that Fernandez will attempt to strike a relatively moderate tone if he does come to power as a debt restructuring at the start of his term will likely prove very distracting from his main policy agenda. Whether or not he will prove successful in gaining investors’ confidence to ensure adequate rollovers and new financing for 2020 is of course yet to be seen and the market has moved to price a high likelihood of default in 2020.
  • China allowed the yuan to weaken past 7 against the US dollar as trade tensions with the US escalated, prompting the US to label China a currency manipulator and deepening the risk-off sentiment at the start of August.
  • In Hong Kong, there were continued violent protests which disrupted flights at the airport and have begun to draw a stronger response from Beijing. Marches are planned for this weekend and the size of these will be crucial to determining the ongoing threat to stability in the region.
  • Turkey’s central bank removed at least nine senior ranking officials in a major overhaul, which should bring the central bank even closer to President Erdogan.

Market outlook

There are many moving parts to the current outlook. On the macro front, the Chinese data is disappointing and suggests the domestic economy is losing momentum.

In the eurozone too, the data remains weak – most noticeably in Germany where the impact of global trade concerns are perhaps most evident.

In the US, the economy looks better than elsewhere but the outsized moves in US Treasuries indicate the future is unlikely to be so bright there either.

Trade worries are partly to blame for the current malaise and it was notable that just as equity markets have started to wobble, President Trump announced a delay in the 10% tariff on USD150bn of Chinese imports.

This new set of tariffs was always the most sensitive given it will most directly impact the US consumer.

With the 2020 presidential campaign underway, President Trump has to be sensitive to domestic considerations.

The slowing global economy and an unclear trade outlook leave investors counting on accommodation from global central banks. There is clearly an easing bias globally, but market expectations have moved a long way – it will be a tall order for central banks to ‘out dove’ the market.

Also, as recession draws nearer, the key question, in our view, that remains unanswered is how effective will central banks be as they continue pumping cash into the economy and pushing interest rates lower?

For EM, the global backdrop is supportive from the basis that ultra-low core yields will draw investors into the asset class, however, the weaker growth outlook will be an offsetting headwind.

That would argue for differentiation within the asset class, with hard currency credit and local rates the preferred longs, while FX would need to be much more selective.

Of course, the events in Argentina last weekend are also still playing out for EM investors as many have experienced large VAR shocks to their portfolios and are likely having to de-risk in other areas.

While this is a dynamic that can shape markets in the short term, with the bulk of the pain already being taken in portfolios this month, it is unlikely to have a lasting impact, in our view.

It is also a good reminder that we use ‘EM’ as a very loose term to describe a hugely varied set of countries that have very different drivers.

We believe the key message is that differentiation will only be increasing as we head into an uncertain final four months of the year.