100 Argentine peso notes are displayed for a photograph in Buenos Aires, Argentina. (Photographer: Diego Giudice/Bloomberg)

Argentine Bonds Sink Into Distressed Territory as Macri Falters

(Bloomberg) -- Argentine markets fell for a second day as the chance of a potential default rose to over 60 percent on doubts that President Mauricio Macri will be able to fend off his populist foes and win re-election this year.

Yields on the government’s short-term dollar bonds rose as high as 20 percent, well into territory that analysts consider distressed, before trailing back to 18.24 percent on speculation the selloff was overdone. The peso is also off its lows for the day, though it’s still down 2 percent.

This week’s declines mark a setback for a country that weathered a market rout last year when it scored a $56 billion lifeline from the International Monetary Fund. Now the economy is back in recession, inflation is above 50 percent and investors are concerned Macri will lose October’s presidential election, with former president and populist Cristina Fernandez de Kirchner rising in the polls. The crisis prompted Macri to announce price controls on food products last week that some analysts said smacked of panic.

“The market is clearly freaking out about political outcomes,” said Whitney Baker, the founder of New York-based Totem Macro, which advises funds holding more than $3 trillion in assets. “It risks literally creating the negative political outcomes the market is worried about in the first place.”

Argentine Bonds Sink Into Distressed Territory as Macri Falters

President Macri says the market is exaggerating the political risks.

“The world isn’t sure whether Argentines want to go back, and that makes the world very concerned -- sovereign risk goes up, they take more defensive positions,” Macri said in a radio interview. “I think they’re wrong, they’re wrong. We Argentines aren’t going back” to the past.

Argentine Bonds Sink Into Distressed Territory as Macri Falters

The implied probability of a default over the next five years has jumped to 61 percent, according to trading in credit-default swaps. Just a year ago, that reading was 23 percent.

Too Much?

The crisis has pushed yields far above similarly rated emerging market sovereign debt, including Lebanon and Turkey.

“Valuations are very attractive, but this volatility is hard to stomach,” said Graham Stock, a senior strategist at BlueBay Asset Management in London. “The main challenge is that local sentiment via the exchange rate will be the key factor in coming weeks and months, and the Macri administration has very few levers.”

Argentine Bonds Sink Into Distressed Territory as Macri Falters

Other investors are beginning to see some value.

"I would be very reluctant to be completely out of Argentina here," said Paul McNamara, a London-based investment director at GAM. “The currency is cheap, and unlike when this happened last year they have a huge external trade surplus, they have a huge package with the IMF that reduces the amount that they have to borrow.”

Negative Loop

The market selloff is exacerbating the economic woes as rising borrowing costs and a weakening peso translate into higher inflation expectations, eroding support for Macri, JPMorgan analysts wrote in a note late Wednesday. That “negative feedback loop,” combined with worse-than-expected inflation, are the main drivers behind Argentina’s dire situation, they added.

“The market seems to be looking for a circuit breaker to that negative feedback loop,” the analysts said.

Polls increasingly show that Macri could narrowly lose a runoff vote against Kirchner, who would likely reverse the current administration’s pro-market policies. Macri’s approval rating is hovering around 30 percent, while Kirchner has risen to 36 percent in recent weeks. Still, pollsters say the race is too close to call.

The IMF bailout has done little to stabilize Argentina. Inflation, the top issue on voters’ minds, hit nearly 55 percent in March, the highest level of Macri’s presidency, and the peso is down 16 percent this year, by far the worst in emerging markets.

Central bank officials have pulled out all the stops to reel in inflation, to no avail. Interest rates have risen to 68 percent, the highest in the world, as policy makers freeze the amount of money in circulation. Still, Economy Minister Nicolas Dujovne and central bank President Guido Sandleris may have no response for this selloff, analysts warn.

"What’s Dujovne or Sandleris going to say if the market is losing faith that the president won’t be re-elected?" said Matias Surt, chief economist at Argentine consulting firm Invecq.

©2019 Bloomberg L.P.