President Javier Milei is intensifying his defense of Argentina’s currency in anticipation of another substantial local debt auction, exacerbating the strain on the banking system and the wider economy as he combats inflation. The government is conducting an auction on Wednesday for peso notes and dollar-linked securities, marking the second such event in a fortnight. This initiative seeks to refinance approximately nine trillion pesos (US$6.6 billion) in imminent maturities. On August 13, officials succeeded in placing approximately that amount, a sale that did not meet expectations and compelled authorities to tighten liquidity measures to safeguard the peso.
This time, they are adopting a risk-averse approach. On Monday, policy-makers raised the required reserve ratio for commercial banks, compelling them to acquire additional government debt. The actions taken absorbed liquidity, supporting the delicate currency that had posed a risk of reigniting inflation. It all points to one straightforward calculation by Milei ahead of the congressional elections in October – following years of rampant consumer price increases and a depreciating currency, Argentines prioritize inflation over economic growth. “The government appears to be prioritizing a significantly elevated real interest rate that impacts economic activity to temper the increase in the exchange rate,” stated Matías Montes, head of strategy at EMFI Securities.
The policy provided the peso with a temporary reprieve on Tuesday, interrupting a four-day decline as market participants expect that no additional pesos will enter the economy, even if Wednesday’s auction does not meet its rollover target. The currency appreciated by as much as one percent following its decline to a three-week low the previous day. “The economic team anticipated a possible low rollover and modified the reserve requirement policy prior to this new tender,” stated Diego Chameides, head of research and strategy at Banco Galicia. With the changes, “the Treasury is guaranteed a demand of approximately five trillion pesos in the bonds they are offering,” he added. The authorities appear to be engaging in a strategy of delay. On September 7, voters in Buenos Aires Province will cast their ballots to elect local lawmakers and municipal councillors. The outcomes will reveal if Milei can generate traction for the October midterms and instill confidence in investors regarding the durability of his reform agenda.
In the interim, the defense of the peso is incurring significant expenses. The yields on local notes referred to as Lecaps have nearly doubled over the past month, exceeding 90 percent in anticipation of the upcoming auctions. They are presently at 75 percent. The rise is elevating funding costs and constraining profit margins at banks that are already grappling with a surge in overdue debt. The shares of Argentina’s largest banks listed on Wall Street, including Galicia, Banco Macro, and Supervielle, have experienced declines of up to 47 percent over the last three months. With the contraction of liquidity, the expansion of bank loans is experiencing a deceleration. The sector, accustomed to reaping benefits from investments in Treasury securities under the previous administration, saw private lending nearly double by March compared to the previous year – marking one of Milei’s significant financial accomplishments.
However, the currency turmoil in July abruptly disrupted that trend, as the government’s debt policies compelled banks to withdraw funds from the private sector and redirect them into government securities. Argentine assets are experiencing significant pressure stemming from a multitude of political and economic challenges, which investors worry may negatively impact Milei’s reputation in the lead-up to the October election. Following a setback in Congress regarding his attempts to control spending, fresh corruption allegations have emerged at the upper echelons of government, implicating Milei’s sister, Karina. While the implications for voter sentiment remain uncertain, this development undermines the President’s anti-corruption image.
In recent weeks, there has been an uptick in investors’ inflation expectations. The breakeven rate on short-term local bonds increased to over two percent per month for September and October, rising from 1.7 percent in the preceding month, as reported by the local brokerage Amauta Inversiones. Risk perception has heightened, as evidenced by the additional spread investors require to hold Argentina’s debt, which has expanded to 829 basis points, marking the highest level since the nation entered into a new agreement with the International Monetary Fund in April.
Dollar bonds have lagged behind their emerging market counterparts, experiencing a decline of over five percent in the past week. On Monday alone, they declined by more than two cents on the dollar, as investors sought to comprehend the political ramifications stemming from the corruption allegations. In August, a prominent index measuring government confidence, compiled by Torcuato Di Tella University, reached its lowest point since the commencement of Milei’s administration. “The second leg of reforms that Milei needs requires support in Congress, but if this scandal gains traction a few weeks before the election, the situation becomes more complex,” stated Claudio Zampa, founder of Switzerland-based Mangart Capital Management. “This is a marathon, not a sprint.” “If it’s not sustainable, eventually you have a problem.”