When behavioral changes of the magnitude of those that occurred last week occur, the first goal is to try to understand them. Understanding the origin helps to measure the scope and implications for the future.
Last week a strong outflow of assets from the National Treasury began towards other assets with less volatility. In a small market, when several relevant players are heading in the same direction and there are no counterparties, price volatility is very significant.
Let’s start by analyzing the possible reasons for these behaviors.
Negative Macroeconomic Signals:
- The first trigger is a significant worsening of the macroeconomic outlook. The fiscal data for the year have been reflecting a worrying increase in Primary Expenditure, which is rising at a rate higher than nominal GDP and tax collection, riskily increasing the deficit. The acceleration in spending goes beyond the increase in the cost of energy.
- In addition, the BCRA has not been able to accumulate reserves in a seasonally favorable period and with an excellent liquidation of agriculture.
- Finally, the difficulties of the Treasury to “roll” its debt at the time it wanted to anticipate the electoral process and improve the maturity profile were added.
Market / Liquidity Aspects:
- In an already complex and expectant context due to economic uncertainty, some market aspects were added that accelerated the process. First, a seasonal period of high liquidity needs for tax purposes, including the need to unwind positions in Mutual Funds.
- In addition, there was a rate of accrual of CER assets that is beginning to drop after having run for several weeks at rates above 100% of the effective rate, making short instruments that had been yielding strongly negative spreads on inflation less attractive.
- And finally, specific rumors were added about the management of the debt in pesos that some opposition economists would propose.
These factors combined to generate a strong storm in a few days. The best way to understand the events is through the evolution of net subscriptions and redemptions of the different categories of Mutual Funds (FCI).
The stress began on Wednesday 8 with the redemption of FCI positions in the T+1 category and Fixed Income (mainly CER). This led to the sale of assets to meet liquidity needs and therefore fed back the drop in asset prices and generated new outflows.
The information as of 06/15 shows that this exit process is already being stabilized. Mainly what happened was a transfer of T+1 and CER funds to the Money Market. This implies that investors sought to lower their exposure to assets with greater volatility such as Treasury bonds and went towards funds with rate accruals and without market risk.
This dynamic confirms a differential aspect that is given by exchange controls, investors can choose different destinations for their pesos, but the total stock does not change. This implies that a liquidity crisis like the one in 2019 will hardly be repeated.
In terms of parities, the strongly negative spreads seen on the CER curve weeks ago look unlikely to repeat themselves.
This is where the recently published inflation data for May 2022 comes into play. The price increase was 5.1%. This implies that between June 16 and July 15, the rate of accrual of CER assets will be 83% (it was 120% in April/May and 100% in May/June). This lower accrual leaves no room for such negative returns on the short end of the CER curve.
The question that arises in the future is at what level the inflationary rhythm can be stabilized. For now, there are factors that explain a certain tendency towards a slowdown, such as essentially the stability of the price of raw materials. But there are other factors that lead us to think that the inflation floor will remain high and it will probably be very difficult to break the floor of 4/4.2% per month.
The factors that explain this high inflation floor are:
- Rate of depreciation: It has not fallen below the 4% average in recent months and needs to be sustained in order not to lose the real exchange rate.
- Fiscal and Monetary Expansion: That in nominal terms has also been growing around these values, with the implication in terms of injection of pesos.
- Wage Policy: The need to recompose real wages via increases after the deterioration implied by the months of high inflation generates greater demand and the need to recompose margins in the services sector.
- Rates: In the coming months, the readjustment of rates will continue, either due to a higher price of the service or due to the elimination of subsidies. This adds direct pressure on the CPI and indirect pressure through the impact on the cost of producers of goods and services.
Taking these factors into account, our inflation scenario for 2022 remains around 77%. This figure is just above the current market consensus. This has created an additional challenge for the BCRA when defining its interest rate policy.
Recent history has shown that interest rates end up losing with inflation. That is why the BCRA decided on a new rise. In this case, the increase was 3 points in the 28-day Leliqs rate and 4/5 points for retail and wholesale time deposits, respectively. It has not yet been defined whether it will apply changes to the rate of 1-day passes.
This scheme brings the rate of wholesale Time Deposits to a level of the order of 4.2% per month, resulting more in line with the rate of depreciation of the exchange rate of 4% per month. It still looks low relative to inflation expectations.
The specific need now for the economic team is to generate incentives through interest rates to ensure that the flow of pesos is once again channeled into Treasury instruments. This surely implies keeping the spread between repos and leliqs as high as possible and probably increasing the spread that the Treasury pays over BCRA instruments. In that sense, the recent rise in rates works against him, because it forces the Treasury to pay an even higher premium. This implies that they have prioritized the impact on the exchange rate gap before the financial cost of the Treasury.
In the short term, the focus will be on the tender of June 28moment in which the Treasury needs to renew maturities for $600 billion. The way in which this tender turns out will be a preview of what is expected for the coming months.