Morgan Stanley Isn't Buying This Week's Argentina Peso Rally

(Bloomberg) -- Investors heartened by the stronger-than-estimated support for President Mauricio Macri’s party in last weekend’s elections sent the peso to the biggest gain in emerging markets this week. But Morgan Stanley says the rally is due to reverse course.

The bank has the most bearish stance on the peso among forecasters, predicting the currency will weaken 6.2 percent to 18.5 per dollar by the end of December and to 22 by the end of next year. That compares with a median estimate of 17.8 pesos per dollar by the end of 2017 and 18.57 by late-2018, according to analysts surveyed by Bloomberg.

The peso is bound to drop because of Argentina’s high inflation and widening current account deficit, which is growing as portfolio flows to the country taper from the highs seen after Macri unexpectedly won election in November 2015. While primary elections Aug. 13 showed stronger support for Macri’s pro-business policies than many analysts had predicted, that isn’t enough to justify any long-term gains after the currency rallied 2 percent this week, according to Andres Jaime, an emerging-market strategist at Morgan Stanley in New York.

“There are some secular forces that are likely to drive the Argentine peso lower,” Jaime said.

Here’s his thinking in more detail:

Current-account gap will hold peso back

  • Argentina’s current-account deficit -- the broadest measure of trades in goods and services -- is near the widest in more than 15 years because foreign direct investment and portfolio flows aren’t coming in fast enough
    • The easiest way to fix this would be luring more investment funds, but money managers will hesitate to come in with the peso so overvalued, according to Jaime
    • Further dimming the outlook for the peso is that currencies with high dependency on portfolio flows tend to be more sensitive to any flight from risky assets

Peso is way too expensive to attract foreigners

  • The peso is at least 10 percent and as much as 15 percent overvalued when taking inflation into account
  • "The currency is too expensive to make local assets attractive”
  • Even if the peso were to fall to the level Morgan Stanley forecasts, the currency would remain in expensive territory when considering annual inflation tops 20 percent, Jaime said

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