Argentina Inflation: Cautious Optimism

Mid Week Bond Update

Argentina Inflation: Cautious Optimism

Argentina's IMF-supported recovery is showing early signs of success.


Argentina’s record-breaking September agreement with the International Monetary Fund (IMF) contained a unusual feature designed to reduce inflation pressures: an aggressive target of 0% growth in the country’s monetary base.[1]

Though the ink is barely dry, there are signs that the agreement may be gaining traction. First, growth in Argentina’s money supply, as measured by M2, [2] is headed downward, coming in at the end of October at about a 15% growth rate -- down more than half from its 2017 peaks in the 35% range. That’s especially notable given the $57 billion in loans from the IMF.

Second, inflation for the month of October 2018 came in at a 5.4% monthly rate, down from 6.5% in September, avoiding the runaway hyperinflation that can take hold when the market views rescue measures as inadequate. However, with the most recent annual inflation rate at 46%, it will take time for even the most successful measures to echo through the country’s economy.  

 

Chart: Courtesy Brandywine Global, Nov 19, 2018. Sources: BRCA (Argentina's central bank), Argentina’s Bureau of Census, (Dirección Provincial de Estadísticas y Censos, Historia (DPEyC/H), Haver Analytics. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

 

The chart above (courtesy of Brandywine Global) suggests that Argentina’s  money supply has been closely linked to inflation, although with a lag. That augurs well for the country’s progress as it gets its own financial house in order. If the Argentina/IMF plan ultimately succeeds, the prospect of high yields and currency appreciation could prove attractive once again to adventurous investors.
 

On the rise: U.S. credit spreads

There’s been a notable pickup in credit spreads in the U.S. since the start of the quarter, with the average investment grade spread rising from 105 basis points (bps) on October 1 to as much as 132 bps on November 20.[3] For U.S. high-yield debt, the spreads have widened more dramatically, from 309 bps to as high as 426 bps over the same period.

The moves, though notable, are not altogether surprising given recent dynamics in the energy sector.  In the market for corporate bonds, energy companies , especially exploration and pipeline companies, borrow heavily to finance growth when fuel prices rise. But since the end of September, the spot price of Brent Crude Oil is down nearly 30%, from $84.98 to $60.36; WTI crude fell just over 31%, to $51.66. 

In addition, some of the uncertainties of the current global trade regime may have discouraged capital investment by U.S.-based companies looking for opportunities whose return on capital is sufficiently predictable to anchor new borrowing. So even though the quarterly earnings season just now winding down exceeded expectations for many companies, future earnings, as well as company-led investments, may leave spreads at their current levels, if not higher.
 

On the Slide: U.S. Capital Expenditures

The most recent figures from the U.S. Bureau of Economic Analysis show non-residential business investment rose 0.8% for the quarter ended September 30, 2018, versus the previous quarter.  That’s a much slower level of growth than seen in the two previous quarters (8.7% in Q2  and 11.5% in Q1)  – and may have contributed to the strong earnings reported by corporations for Q2 and Q3.

These figures are watched carefully for clues about future growth in the U.S. economy, with capital expenditures (capex) seen as a harbinger of growth, as well as of optimism about the availability of investment opportunities.

But the relationship between capex and future growth is by no means certain; in part because there are both sources and uses of capital outside the U.S. that could contribute to U.S. growth. In addition, any reduction of policy uncertainty or geopolitical tension could result in a rapid change in the investment outlook of U.S. corporations as they plan for future growth.

 


[1] The monetary base is the total amount of a currency that is either circulated in the hands of the public or in the commercial bank deposits held in the central bank's reserves. This measure of the money supply typically only includes the most liquid currencies.

[2] M2 is a measure of money supply that includes cash and checking deposits (M1) as well as near money. “Near money" in M2 includes savings deposits, money market mutual funds and other time deposits.

[3] As measured by the Bloomberg Barclays U.S. Aggregate Corporate Average Option-Adjust Spread (OAS).


Definitions:

A spread is the difference in yield between two different types of fixed income securities with similar but not identical characteristics, such as maturity, credit quality or currency.

One basis point (bps) equals 1/100 of a percentage point.

 

 

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