It took less than a week – and a landslide defeat for free-market reformer Javier Milei – to make Morgan Stanley abandon its bullish call on Argentina.
The Wall Street bank, alongside rivals including Bank of America Corp and JPMorgan Chase & Co, advised clients to buy the government’s bonds ahead of a key local election in Buenos Aires Province this weekend, betting that the president’s recent political stumbles had already been priced in during sell-offs that swept through the nation’s financial markets the past few months.
On Sunday evening, word came that Milei’s party had been handed a crushing defeat in the vote, a troubling sign ahead of nationwide congressional elections next month, and by Monday morning, the bullish calls had backfired spectacularly.
Some of Argentina’s hard-currency bonds tumbled by nearly seven cents to 55 cents on the dollar, the steepest drop in two years, sending the yield hurtling up to 12.7 percent. The local stock market tanked 13 percent in the worst one-day rout since the onset of the pandemic. And as global investors rushed to the exits, the peso slid as much as seven percent to a new all-time low. As the sell-off got underway, Morgan Stanley ditched its optimism.
The rout sent a clear message: investors are increasingly concerned that Milei, ensnared in a corruption scandal involving his sister, will suffer such a rebuke in next month’s vote that it will hobble his ability to push through the reforms needed to cement the gains he’s made in slashing inflation and sparking an economic recovery. For investors long accustomed to the wild ups and downs in Argentina, a country that’s defaulted on its debts nine times over its history, a plunge back into crisis was suddenly a very plausible scenario.
“With market uncertainty set to last, we move to the sidelines despite likely much cheaper levels today,” Morgan Stanley economist Fernando Sedano and strategist Simon Waever wrote in a note, also removing their “like” stance on the dollar bonds.
The market turmoil on Monday underscored how much Milei’s political power has been battered by reports of a bribery scandal involving his sister and purported kickbacks paid in return for government pharmaceutical contracts, which the government has denied. The reports have tarnished his reputation as a radical reformer and outsider untainted by politics as usual. Irate protesters have gone so far as to pelt him with rocks during a recent public appearance.
Milei had been expected to be handed a defeat in the local election, but the magnitude of his party’s loss to the left-leaning Peronist opposition – the gap was almost 14 percentage points – surprised investors and spurred talk that the president would shake up his cabinet to contain the damage. Milei said he was embarking on “deep self-critique.”
A market star
Milei, a libertarian economist, had become a favorite of global investors for enacting deep spending cuts that reduced a bloated budget deficit and sweeping free-market reforms in a bid to turn around South America’s second-largest economy. His shock therapy was beginning to show some success, leading to a plunge in inflation, a surprising budget surplus and a US$20-billion deal with the International Monetary Fund.
The result unleashed a strong run in Argentina’s markets, sending shares higher and handing owners of its dollar bonds a 136 percent gain since Milei was elected, lagging only Lebanon and Ecuador among emerging-market debt tracked by Bloomberg.
Those returns stoked optimism among some strategists, and some anticipate that Monday’s sell-off may be short-lived.
JPMorgan strategists Luis Oganes and Jonny Goulden on Monday reaffirmed their overweight recommendation on Argentina’s sovereign bonds, saying they anticipate that Milei will be able to salvage his reform agenda and “recalibrate its political strategy to address missteps.”
Bank of America, which has been holding an overweight rating on Argentina debt since mid-2023, also maintained the stance in a note after the election results, though its strategists warned that investors are likely to brace for “less market-friendly” outcomes next month.
While some money managers have been trimming exposure after reaping triple-digit returns since Milei rose to power in late 2023, Argentina remains an overweight among institutional investors and hedge funds, according to a note from Goldman Sachs Group Inc’s trading desk seen by Bloomberg.
But the political dynamics are now fanning concerns about the precarious nature of the nascent turnaround heading into next month’s legislative election. The government had already started wading into the currency market to try to prop up the peso.
“The next seven weeks until the October election will be critical to assess whether the government can control the damage,” Andrés Borenstein, an analyst at BTG Pactual wrote in a note. “But any meaningful improvement in Argentine asset prices will likely have to wait until the end of October at the earliest.”
As Milei approaches the middle of his tenure, the legislative vote will be key to whether he can continue to push Argentina down a new economic path. His defeat in the Buenos Aires Province election echoed the one Mauricio Macri suffered in the primary election in 2019, which fuelled fears that his pro-business policies were coming to an end.
Meanwhile, Milei’s strategy to stabilise the currency is unravelling. The peso has been hovering around record lows since August, despite the government’s efforts to ease dollar demand by squeezing banks’ liquidity and directly intervening in the exchange market, a move that spooked investors even more. The peso was trading above 1,400 per dollar on Monday, getting closer to the upper level of the band set by policymakers.
“We see room for further volatility in the run-up to the October” vote, said Kathryn Exum, co-head of sovereign research at Gramercy Funds Management. Prospects for Argentina to regain market access or the need for the country to do liability management next year “will hinge on Milei’s performance in October – and more importantly on policy execution in the aftermath.”
Despite the negative sentiment, Milei vowed to double down on his economic plan in a speech just after the Buenos Aires results were announced, claiming that the mistakes that led to the poor electoral outcome came mostly from the political front.
“A drastic change in political leadership” and a healthier alliance with other parties “would be very positive,” said Joaquin Bagues, managing director at local brokerage Grit Capital Group, which is maintaining a buy-on-weakness bias. “Better an early correction than a late one.”
by Vinícius Andrade & Nicolle Yapur, Bloomberg
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