Argentine Peso - High carry with the bonus of portfolio diversification

The Argentine peso (ARS) is no stranger to volatility, with the country having endured eight bond defaults since its independence in 1816. After the last two bond defaults in 2001 (the world’s largest at the time) and 2014, the ARS had enjoyed a period of relative stability, thanks to President Macri’s pro market reforms.

During 2018, the rising US dollar exerted significant pressure on countries who relied on US dollar funding for their government borrowings. In June, confidence in Argentina had deteriorated and President Macri approached the International Monetary Fund (IMF) for a bailout package to combat a currency crisis, runaway inflation, and a struggling economy. By September 2018, the currency had depreciated by 170% against the USD, rising from 15.1 in March 2017 to a high of 41.5.

It is interesting to note that the ARS has a very low correlation to key asset classes such as US equities, global equities, global high yield bonds, and USD denominated Emerging Market (EM) bonds despite the increased volatility in these asset classes over the last two years. The ARS is only slightly correlated to EM local currency bonds and Argentina USD bonds. It is however correlated to Latin American currencies such as the Brazilian real, although this should come as no surprise as Brazil is Argentina’s largest trading partner.

What is surprising however is that the ARS has a low correlation to other high beta emerging market assets such as the Turkish Lira (TRY). This observation holds true for the period before the IMF package was approved at the end of June 2018 as well as after, when Argentina introduced a currency trading band. See Fig. 1. On balance, the ARS’ low correlation to key asset classes and selected emerging markets is the by-product of the idiosyncratic risks that have enveloped Argentina’s economy, in our view.

Fig. 1. Argentine peso: 2-year weekly correlations against selected positioning¹

Holding ARS outright in multi asset portfolios provides high carry (as much as 39% per annum), and as a bonus, diversification benefits. In an environment where most G10 central banks still have low interest rates, higher yielding assets are attractive.

The risks to this view include the upcoming Presidential elections, stubbornly high inflation, persistently weak growth, and external market volatility. The upside, on the other hand, is that Argentina has seen an improvement in its economic activity in December. Its merchandise trade balance was positive over the last five months ending January 2019. The government’s primary deficit also fell to 2.4% of GDP in 2018, from 3.8% in 2017. The adjustments are happening albeit at a slow pace. Apart from domestic reforms, we believe that a benign Fed environment will also be supportive of emerging markets, including Argentina.