Expectations Don't Feed Us

Activity is Still Waiting for Recovery. There is still no definition of New Letters. In a Quieter Week, the Dollar Continues to Rise While the Blow to Bonds and Country Risk Continues. It's Hard to Rise from the Ocean Floor Without Facts; Expectations Are Beginning to Run Out.

Dear ArgenGrowther,

Every week, we have the primary data from the past week and delve into different aspects of our beloved Argentina to see their impact, understand what's happening, and make better decisions. The FInancial ArgenGuide is divided into four main sections:

1. Data
2. Understanding What's Happening in Detail
3. Actionable Items
4. Brief Reflection

Financial ArgenGuide:

#data

What does all this mean?

Positive or negative? Spoiler answer. Neither. Are no news good news? With a focus on the new Letters and what's coming, negative activity data continues, and doubts in the financial sphere persist. Would you like to see any additional data? Tell me which one.

Understanding What's Happening in Detail

Dollar and the Strong Peso It's been another busy week here. The dollar continues to rise amid much uncertainty about the new Monetary Regulation Letters (LRM) and their implementation. The MEP dollar hit its historical nominal record, but if adjusted for inflation, we are far from where the currency moved in recent years.

The improvement in the Central Bank of Argentina's (BCRA) balance due to eliminating liabilities can support and strengthen the peso. A currency recomposition without inflation can lead to the strong peso regaining prominence. This week, there will be a strong flow of dollars in private hands due to the payment of the Bonares. Will part of these dollars translate into supply and lower the MEP dollar?

On the other hand, rumors of an increase in the Monetary Policy Rate are beginning. As we have mentioned several times, the government has stated that the era of negative real rates is over. However, some adjustments still need to be made. Although market-adjusted Lecaps are above 4% Effective Monthly Rate (TEM), inflation is still above that number, and the rates offered by banks are even further from covering inflation.

Greater uncertainty = Greater volatility

Greater volatility = Less stability

Less stability = Worsening economic expectations

Worsening economic expectations = Greater pressure on the exchange rate

At the same time, we see that the payment of imports continues to normalize. The demand for dollars for payments will likely be significant in the coming months, considering that a considerable proportion of payments were postponed in the first part of the year.

Recomposition of Public Accounts

Central Bank of Argentina - BCRA

The end of monetary issuance will give way to a new economic model that has nothing to do with what was happening in Argentina, especially in recent years. Eliminating issuance to finance the Treasury (mainly to cover the fiscal deficit) and to pay interest on remunerated liabilities (on the way to extinction), we move to an Argentina that does not issue. And now what? That's what we all ask ourselves. What will the new monetary scheme be in Argentina? How will the pesos issued for reserve purchases in a zero monetary issuance program be absorbed? How will growth occur?

Zero monetary issuance = Less Inflation

Zero monetary issuance = Contractive monetary policy

Contractive Monetary Policy = Less activity

Less activity = Less Inflation

Soon, we will see a different chart type since remunerated liabilities will cease to exist, and monetary issuance will have a different story. The Monetary Base will become more relevant for its composition, which differs from what it had been. Remember that the contractive fiscal policy has been added to the contractive monetary policy. If we add a positive real rate, we have a combination that can significantly impact economic activity. How do we get out of this? Will dollars come out from under the mattress to bet on the country's growth?

Contractive Fiscal Policy = Less economic activity

Contractive Monetary Policy = Less economic activity

CFP + CMP = Less economic activity

Last week, we said it seemed the government devised this system to transfer a positive real rate for pesos to the market without having an associated cost at the BCRA that impacts the pesos' stock. Today, rumors of rate hikes are getting stronger.

The government began talking with banks, and we have more information about the LRMs or LEREMO:

• The Central Bank will put a bid (purchase order) at technical value, allowing banks to manage liquidity as they did with repos.
• The bid would justify saying that LRMs do not count towards the limit on financing the Public Sector (similar to puts).
• When the Treasury pays, it is exempt from gross income taxes, which improves the transmission of rates to investors.
• It will be exclusive to banks, so intermediation with other market agents will continue as usual.
• As mentioned, the coupon will adjust to the monetary policy rate (the same as Notaliqs) and will be capitalizable (the same as current Lecaps) to avoid affecting the fiscal result.

? The BCRA board meets on Thursday, and communications will follow to provide the regulatory framework and begin operations.

Given the new conditions, banks will likely raise fixed-term deposit rates in the coming weeks.

National Public Sector Balancing Public Accounts

Much is being said about the migration of BCRA debt to the Treasury, but little is said about the cushion the Treasury has in the BCRA. 14 trillion pesos were placed in the BCRA to face the assumption of new debt commitments. This means that the surplus will have to consider an additional hurdle. Still, there seems to be room for maneuver, considering the fiscal cost today is approximately $585,000 million monthly. It is essential to highlight that as the Treasury increases its debt, its credit quality logically decreases (while the BCRA's improves).

Let's go with a not minor aspect of accounting public accounts: the Net Non-Financial Primary Surplus (SPNNF) is accounted for on a cash basis. What does this mean, and why bring it up here? Here, the government can play with the fine print, given that a zero-coupon letter or bond does not pay explicit interest (the interest is implicit in the price), allowing for a surplus as long as there are no problems in rollover auctions (paying debt with new debt auctions).

Auctions

We already have the instruments to be auctioned this week:

• Lecaps on 16/8/24, 13/9/24, 14/10/24, and 17/1/25. There is no TEM this week, and there is no cap.
• Dollar Linked on 30/6/26 at a minimum IRR of -2% and on 30/6/27 at a minimum IRR of +1%

For the first time in a long time, we see a positive Internal Rate of Return (IRR) for dollar-linked bonds, but to get this positive return, one must extend terms until mid-2027. Another relevant point is that there is no cap; we'll see if this indicates the peso vacuum coming or if they continue to exclude a mountain of pesos from the auction. Remember that this week's maturities barely exceed a trillion pesos.

Economic Activity

The harsh reality of economic activity we have been talking about continues. Again, we record a furious red in the year-on-year comparison, and we don't reach green in the monthly comparison for the index that measures manufacturing activity: -14.8% year-on-year and -0.2% monthly indicate that the rebound is not yet present. The street? Holding on. The tourniquets applied by the government's economic policy are difficult to assimilate in a country in total crisis and a population that has been holding on for many months. Is there any news on the way that they don't want to communicate yet that will have a solid short-term impact?

Capital Markets - Actionables

After many turbulences, the market starts to calm down. The dollar-linked coverage continues, but it seems more related to risk management than a belief that the government will devalue.

Last week, we said that for those who believe in the government and want to bet on carry, it can be a trade with a lot of profit. With the MEP rising this week, this scenario has not yet been validated, but the premise remains: selling at these values and being short the spread can lead to extraordinary profit with high exchange rate risk. Does the trade-off pay? The greater the spread, the greater the incentive to sell dollars and carry. Timing is everything here. Is it time to carry trade with rumors of a TPM increase, the recent dollar surges, and the increasing spread? (only for aggressive investors willing to take on significant exchange rate risk).

The Merval continues to have high volatility, and the markets abroad do not favor Argentina now. We continue to watch what's happening in Brazil and Mexico closely.

This week, we have the amortization and interest payment for the Bonares to have fresh money in the market. How much of that money will be reinvested? Suppose the fiscal surplus is non-negotiable, good investment news, and fresh money is obtained (without urgency for bonds). In that case, the country's risk will eventually adjust, and bonds will reflect this in lower yields and better prices.

Given the BCRA to Treasury movement, we see the BCRA's balance improving, reducing the risk of Bopreales. We also see an excellent opportunity to seek good hard-dollar title yields with BCRA risk.

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Brief Reflection

We open with a tweet from the Minister of Economy: "I never believed that intellectual dishonesty would reach the point of reading colleagues complain because the MB is rising. ??♂? That the monetary base is rising is precisely what we want to happen. This is NOT monetary issuance, but a change in the composition of the BCRA's liabilities, which go from remunerated (repos) to non-remunerated (MB), as a result of lower inflation." Here, Toto Caputo communicates what the government is seeking through social media. As the minister mentions, they are very clear about what they want, an obsession since they took office: to eliminate remunerated liabilities or change their composition. With this goal nearly fulfilled, the long road to lifting the exchange controls is paved. The government has given Phase I as completed; zero fiscal deficit is already a reality. This first stage lasted 6/7 months. How long will this second stage of moving to zero monetary issuance take? How long will it take to implement the LEREMO and for the market to accept them?

Capital controls will remain in place long, with no exit date. The government repeats this over and over at every opportunity. What can we look at to know if we are closer now? The Central Bank also has another metric in sight: net reserves, which is fundamental for strengthening the BCRA's balance.

How will the government combat anxiety? A government doing its job without haste (regarding the exchange controls) and without pause faces a market that wants actions now. Oddly, many actors are concerned about the exchange rate factor but not so much about an economic activity that is not rebounding. There is a marked path, but there are still many questions. Will we learn to live in the uncertainty of when and how the country moves forward amid a crisis? This is Argentina; we've lived like this for decades, so the easy answer is yes. But can a non-Peronist government endure? The feeling remains that the government is strong and has broad popular support.

Zero monetary issuance as part of the economic program will help continue anchoring expectations, but can expectations be eaten? Reaffirming a new contractive economic policy towards activity makes me reflect on whether the tourniquet on activity has any safeguard that they are not communicating. Remember that one of the government's pillars is the fiscal surplus, a contractive fiscal policy towards activity. We remain in intensive care; fresh funds are not appearing, and the rebound seems not to be either.

We continue to watch Brazil and the price of soybeans very closely. Both have been playing against the current government, simultaneously putting more pressure on the exchange rate and economic activity. This chart summarizes it very well. A rise in the Real means more pressure on the exchange rate, and a fall in soybeans does the same. Combined, Both factors fuel a fire that never goes out in Argentina.

Even though we are getting closer to lifting the exchange controls week by week, the agony seems endless. Correcting the imbalances in the exchange market is essential so that the country has healthier foundations for growth again.

Argentina needs a highway to do business, not a street full of potholes. Are we closer? Today, I want to believe yes.

See you next week, Vamos Argentina!

If you liked it, I invite you to write to me, comment, share this short column, and reflect on our living moments.

Nau Bernués

Founder, ArgenGrowth

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