China scare adds to Central Bank’s election-week troubles

8th August 2019

By Ignacio Portes

China scare adds to Central Bank’s election-week troubles

The Argentine Central Bank had to sweat throughout the closing week of the campaign to keep markets from unraveling.

Escalation in the US-China trade conflict led to renewed pressure against the peso and Argentine bonds, and Central Bank chief Guido Sandleris went opposite to a global trend of easing monetary policies by raising interest rates further, one of several moves made in an effort to contain the exchange rate ahead of Sunday’s elections.

</p> <p>The peso-to-the-dollar rate stopped short of a new all time high, trading at 45.30 on Thursday. This has so far meant relief for President Mauricio Macri ahead of Sunday&#8217;s vote, but the scare raised new questions about the fragility of the Argentine economy.</p> <h2><strong>Currency wars?</strong></h2> <p>Tremors began on Sunday night, as China let the yuan depreciate beyond the psychological barrier of seven yuans per dollar, leading investors across the globe to run looking for safe assets such as US bonds, and away from riskier emerging markets.</p> <p>Immediately after the news, Argentina’s peso traded almost two percent lower on market open. More troublingly, the JP Morgan EMBI+ Argentina index, or “country risk,” which measures the difference in rates paid by Argentine and US bonds, soared by 8 percent on the day, reaching more than 900 basis points.</p> <p>The Chinese devaluation also led to fears of a currency war across the globe, as proven by yet another jump in the price of gold, the safe haven against currency depreciations.</p> <p>US President Donald Trump’s tweet-storms against Federal Reserve chair Jerome Powell became longer and harsher, arguing <a href="">yesterday</a> for &#8220;bigger and faster&#8221; rate cuts and an end to the &#8220;ridiculous quantitative tightening,” leading investors to expect more cuts in the months to come. That in itself would not necessarilly be bad for Argentina’s debt and exchange rate, but the US was far from alone.</p> <p>Central Banks across Asia and the Pacific <a href="">also cut rates during the week</a>, while investors also worried about the increasing number of European countries offering negative yields for their government bonds. Last week, Argentina’s biggest trade partner Brazil also beat market expectations with a <a href="">bigger interest rate cut than expected</a>.</p> <p>Overall, all Latin American currencies depreciated since Monday, following on China’s lead, but Argentina, Brazil and Colombia led the pack, with others such as Chile, Paraguay or Peru barely moving.</p> <h2><strong>Struggling to meet the targets</strong></h2> <p>Although it didn’t make the headlines, Central Bank chief Guido Sandleris was forced to adjust the interest rate of the benchmark 7-day Leliq note, as demand for pesos and peso-denominated notes showed signs of decline.</p> <p>Sandleris, who <a href="">switched</a> from an inflation targeting system to a monetary aggregates policy when he took over as Central Bank head in September 2018, is forced by his own policy to take a certain amount of pesos out of circulation. This is done by offering Leliq notes to banks in exchange for the bank&#8217;s pesos. If the banks don’t deem the Leliq rates on offer tempting enough to buy the amounts that Sandleris needs, the Central Bank is forced to raise rates on the next auctions to meet the absorption targets.</p> <p>This is what has been happening over the last few weeks. The Central Bank first <a href="">failed to meet its peso-absorption targets in July</a> (but changed the rules saying it would now only be measuring the fulfillment of these targets once every two months). Then, in August, it hiked its average Leliq rate from 60 to 63 percent. But that hasn’t been enough either.</p> <p>“Despite the constant hike in interest rates, almost 300 basis points this month, the Central Bank is not managing to take pesos from circulation, and is getting further away from its monetary base targets,” analyst Christian Buteler said. In his view, Sandleris is gambling on a good result from the government in this week’s election to get out of trouble. “It is not merely the government that needs a good result on Sunday, but also the Central Bank,” Buteler said.</p> <p>Analysts believe that a Macri defeat by <a href="">less than 3 points</a> in the primaries against Alberto Fernández could lead to a recovery in bonds and demand for pesos.</p> <h2><strong>Controlling the pace</strong></h2> <p>Still, the rise in the peso-to-the-dollar exchange rate comes after analysts were seeing the currency as <a href="">overvalued</a>, and it has not been steep enough yet to grab the main headlines across Argentine newspapers (with some exceptions).</p> <p>In 2018 and early 2019, the run against the peso was arguably the main factor damaging President Mauricio Macri’s poll numbers, but his figures have recovered since the <a href="">IMF gave Sandleris</a> additional tools to contain the exchange rate in April.</p> <p>Alberto Fernández’s clear preference for <a href="">lower interest rates</a>, however, has added pressure to the peso over the last few days, as well as the aforementioned devaluation in China. But, as well as raising interest rates, the Central Bank has also been selling its <a href="">profitable positions on currency future markets</a>, a factor that can ease the pace of the exchange-rate swings. Market analysts also believe there’s been unofficial intervention from public-owned banks selling dollars in spot markets to avoid a sharper devaluation.</p> <p>So far, this has been enough to avoid breaking the psychological barrier of 46.50, the previous peso-dollar all-time high. It has also helped prevent days with ultra-high volatility, which can raise fears among the general population. But the gamble is risky: if, for any reason, the dollar continues to strengthen against the peso, the Central Bank will have fewer tools for future intervention, having spent part of its (largely loaned) firepower during election season to prop up Macri’s chances.</p> <h2><strong>All eyes on Sunday</strong></h2> <p>The local consequences of what’s taking place in global markets are still hard to grasp in full, as the situation is ongoing. In the case of soybean (Argentina’s main export), China’s decision on Monday not to buy US shipments was seen as potentially beneficial. As for oil, the price drop seen this week would have been a relief in 2015, as Argentina was a strong importer, but the situation could be different this time around thanks to the development of the Vaca Muerta shale oil and gas extraction hub.</p> <p>The more immediate development to follow will be the election results on Sunday. The first official figures are expected by 9 PM, although they are likely to be slanted, as voting booths from city centers are usually counted faster, and they tend to favor Macri. According to authorities, a more definite trend will be known after midnight.</p> <p>

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Ignacio Portes

Ignacio Portes is The Essential's General Editor. Former Economy editor at the Buenos Aires Herald, he has also written for publications such as Naked Capitalism, NSFWCorp and Revista Debate.