Argentina’s Primary Election Has Investors Flying Blind

(Bloomberg) -- Argentina’s primary election on Sunday will be key in dictating how asset prices will move going forward — it’s just not clear in which direction.

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Amid a wide range of possible outcomes, investors will be looking for signs of the political change needed to bring South America’s second-largest economy back from the brink of another collapse. That’s no ordinary challenge: inflation is running at more than 115% a year while a recession looms.

The primary is designed to allow Argentines to choose the candidates who will compete in the Oct. 22 general election. But it also serves as a barometer of public sentiment, since every contender needs to be on the ballot. While voting is mandatory for most adults, pollsters expect participation to drop to about 70%, a historic low for a presidential election in the country.

Such voter apathy, combined with a history of unreliable opinion polls, is again adding uncertainty for investors. Four years ago, Argentine markets had a meltdown when the primary results caught investors off guard.

“We’re heading into the elections blindly in a certain way, given the inaccuracy of the polls,” said Ramiro Blazquez, head of research and strategy at BancTrust & Co. in Buenos Aires. “Peronism is headed to its worst electoral performance since the nation’s return to democracy in 1983.”

The main contenders in this election are:

• Buenos Aires Mayor Horacio Rodriguez Larreta and former security minister Patricia Bullrich, who are locked in a tight race to lead the market-friendly opposition coalition

• Economy Minister Sergio Massa, who counts on the formidable support of the incumbent Peronist party

• Libertarian candidate Javier Milei, who represents his own party and seeks to capture voters disenchanted by both political powerhouses

Here are three possible scenarios to consider on Sunday:

Opposition Wins Big

Bonds are expected to rally if the combined votes for Larreta and Bullrich surpass 35% of the total, according to Patrick Esteruelas, head of research at Emso Asset Management. That would be a strong sign that the business-friendly coalition known as Juntos por el Cambio, or Together for Change, is poised to win the October election outright, he said.

The nation’s bonds due 2030 gained 1.5 cents this week to touch nearly 36 cents on the dollar, the highest since February, on investor optimism that the bloc may do well in Sunday’s vote.

In order to avoid a runoff in November, the top candidate must receive 45% of valid votes, or 40% of them while holding onto a 10 percentage-point lead over the runner-up. An outright victory would also boost the winning party’s performance in congress.

Yet a crucial question for the opposition’s success is whether Larreta or Bullrich can retain the totality of the votes split between them, after their bitter and very public infighting during the campaign. That’s why investors will be closely watching the concession speech that the losing candidate is expected to give Sunday night. Differences aside, the two have nearly identical economic proposals.

Some investors also worry about how Massa would react in case of a very poor performance on Sunday. They fear that the economy minister would be tempted to boost government spending in order to revert his defeat, deepening the fiscal and currency crises.

Investors are betting on some kind of currency devaluation after the primaries, paying higher costs in Argentina to hedge against an adjustment. Dollar-linked bonds maturing in April 2024 are already yielding a record negative 22% annually.

“When there is demand at these levels, price takes a back seat,” said Sergio Gonzalez, head of asset management at Buenos Aires-based brokerage Cohen. “No one wants to be left out of these hedges because there is a lot of uncertainty about the evolution of the official exchange rate after the elections.”

Ruling Party Outperforms

Bond investors are likely to grow concerned if Peronism proves just as competitive as the opposition coalition. They worry that Massa, 51, would be slow to unwind the patchwork of exchange rates, capital controls and taxes he has resorted to in a bid to stop inflation from accelerating even further.

“Considering Peronism has had a floor of support of about 30%, you can’t completely discount Massa,” said Valerie Ho, a portfolio manager at DoubleLine Group in Los Angeles. “The problem with Massa is that his economic stabilization plan would be gradual, and I don’t think that’s a policy prescription for Argentina.”

While the measures Massa has implemented are largely seen as unsustainable, he is nonetheless considered as the most pro-market politician within his leftist coalition. That leaves some investors betting that his victory wouldn’t be so bad after all, because he would have the political capital to reduce government spending without sparking social unrest.

“The best candidate to make those policy changes may not necessarily be the most market-friendly person,” said Mike Arno, an associate portfolio manager at Brandywine Global in Philadelphia, with around $54 billion in assets. “It may be someone who is politically adept at navigating Argentina politics.”

Outsider Surprises

Markets risk going into panic mode if Milei, 52, snags a quarter of votes or more in the primary. The libertarian congressman’s top proposal to control inflation includes replacing the national peso currency with the dollar — a move that many economists say would trigger financial mayhem.

A win by Milei on Sunday would also increase odds that the election goes to a second round, meaning the uncertainty would last longer. Worse, an administration led by the outsider politician could run into governability issues, given his lack of political support to approve measures in congress.

“Under Milei you may have a shock stabilization plan, but with a lot of wobbles,” said Ho from DoubleLine. “He has no party structure or support in congress, so that shock plan could come with a lot of volatility, and that could be the downside for bonds.”

Again, voter participation is key for his chances of success. Low turnout in the election could drive a surprise victory for Milei, who counts on a more engaged base of supporters than other candidates.

(Updates with expectations for currency devaluation from 12th paragraph.)

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