It is pretty well-known that Argentine sovereign bonds have performed incredibly well in the past year. The change of government, the end of the conflict with its holdouts and the country’s re-entrance in the international credit markets gave local and international investors the necessary confidence to start building positions in Argentina’s debt.
That’s how the country’s sovereigns experienced a massive spread compression all across their yield curve, pushing bond prices higher and yields closer to other LatAm peers. Short duration bonds showed a bigger yield compression than its longer duration counterparts. However, price-wise, longer duration bonds have proved to experience a better overall performance. And it makes total sense, as yield compressions typically reward more longer duration bonds with higher price increases.
But the interesting story here is that the Argentine sovereign yield curve has not only dropped, it has normalized as well. Its inclination changed dramatically as it first went from negative to flat, and then turned positive this year, helping profit more to those who bet on longer durations.
However, during these past few weeks, longer duration bonds especially have experienced a drop in price. What’s behind this correction?
First things first. Although the price drops in Argentine longer maturity bonds is significant, when their impressive YTD gains are taken into consideration, this correction remains marginal and looks more related to big funds closing positions to secure juicy profits – and portfolio managers bonuses – than anything else.
Nonetheless, the real reason behind these moves does not seem related to domestic issues, but rather global trends. Emerging market bonds have been quite volatile these past few weeks, expressing growing fears on a FED rate hike. We can easily see this on the performance of iShares JPMorgan USD Emerg Markets Bond ETF (NYSEARCA:EMB).
We know that there’s hardly anything more announced and waited for than the upcoming FED interest rate hike. It seems clear that the FED still weighs more the contingencies of intervening hurriedly than the risks of acting late, but still, all of the looks are at their December decision and increasing bets have started to pile up.
Make no mistake. A rate hike will certainly have an impact on the emerging bond market as a whole, and it is not impossible to estimate its consequences.
For example, if the US treasury yield goes from the current 1.85% to 3.35%, then the yield of the Mexican 2031 sovereign would have to move from current 3.1% to 4.6% if current spreads are to be maintained. This would correspond to an ugly 20% price drop for this Mexican bond.
Although similar base cases could be projected for Argentine sovereigns, a few factors are still on the country’s side.
A bullish case for Argentina
Despite the strong increases in prices, Argentine sovereign yields remain attractive when compared to the rest of the region. The gap is still big and noticeable:
Given these yields, Argentine sovereigns hold a relatively wider margin when it comes to a FED rate hike. The country pays way more than its peers in a world where negative yields have become the norm.
Nonetheless, the country’s macroeconomic variables must continue their normalization in order to secure confidence in its debt. This normalization involves clear signs that show Argentina’s disinflation path, a moderate but stable GDP growth and proven efforts of fiscal deficit reduction.
If Argentina finds itself following this path, its country risk will continue to converge slowly but steadily toward other LatAm benchmarks like Brazil or Uruguay. And even in the scenario of a gradual FED rate hike, we should continue to see profitability in the longer part of the Argentine sovereign yield curve.
Adrian Limoli is a research analyst and investment advisor.