What is being said at the tables: full official attention to the dollar-inflation duo and investors like Marcelo Gallardo, "with the guard up"

The external climate has soured, but politics, the government, and the local market have also contributed to the rise in country risk. Until recently, the Casa Rosada boasted that Argentina's risk premium had collapsed to 400 basis points after the payment of July coupons and celebrated the improvement in credit ratings. Now, it has risen back above 500 points. Not everything comes from abroad: local factors have also contributed to the escalation of country risk.{#p-1787876817842-31008}

What are they saying in the financial bunkers and trading desks? The head of Research at a legendary over-the-counter boutique summarized it for his clients in a few words: it’s time to position oneself with the guard up, perhaps paraphrasing "Muñeco" Gallardo.{#p-1787876817842-19603}

In good terms, beyond investment recommendations, the local context induces acting with great caution. Today, it seems more appropriate to maintain a more dollarized and indexed position. What could change this mood? asked a manager, who received a hint: watch how the already famous Government Confidence Index from the Torcuato Di Tella University evolves. At a minimum, the expert advised, one should observe an improvement in the indicator over the next few months.{#p-1787876817842-33874}

Globally, there has been a greater aversion to risk, although this does not imply a "credit crunch," that is, a massive liquidation of risk positions. Nevertheless, the deterioration has caused, for example, U.S. corporate debt rated "CCC" ---similar to what Argentina was--- to yield from 10% to 13%. Today, Argentine debt has a rating of "B-".{#p-1787876817842-77649}

But when the political scenario begins to be incorporated into credit evaluation, country risk resurfaces. This is how, for example, the spread by legislation between the sovereign bonds GD30 and AL30 reacts, which has widened again.{#p-1787876817842-14287}

Elections 2027: the market rehearses scenarios and monitors the polls {#p-1787876817842-3309}

Meanwhile, in all financial meetings, the political ingredient dominates attention. At the tables, they outline scenarios for 2027 with and without PASO, including the option of having PAS, that is, non-mandatory Simultaneous Open Primaries, designed for the PJ to resolve its internal disputes and achieve unity.{#p-1787876817842-37992}

Investors assign importance to the PASO because they could define the electoral landscape for 2027. From now until the end of the year, it will be necessary to monitor Congress, advised a political analyst during an economic-financial meeting via Zoom, based on three alternatives: elimination of PASO, suspension of PASO for 2027, or elimination of their mandatory nature.{#p-1787876817842-55307}

The existence or non-existence of PASO will determine whether the market will have to go through three elections ---primaries, general, and runoff--- or only one or two, considering that the elections in the province of Buenos Aires and the City will be simultaneous.{#p-1787876817842-68392}

What should be watched? According to the analyst, the behavior of swing voters regarding the Land Laws, the Organic Charter of the BCRA, cold and warm zones, and the 2027 Budget.{#p-1787876817842-69165}

What appears as new in the local context? Besides observing how the Peronist internal dispute is resolved, the market is closely watching the performance that the left could achieve, which some project as historic. Although the level of image does not necessarily translate into votes, the rise of Myriam Bregman catches the attention of pollsters.{#p-1787876817842-32419}

A myriad of data segmented by age, ideology, and income level circulates. However, in conversations among market leaders, the collapse of Javier Milei's approval rating stands out, which has dropped 10 points over the last eight months to 34%, while disapproval has risen by more than 13 points, exceeding 63%.

The deterioration is heavily concentrated among young people aged 18 to 29, who have not yet migrated to another political space but remain in a sort of limbo. They are defined as angry voters, but potentially recoverable.

During a conference call at a foreign bank, four electoral scenarios were proposed:

• One similar to 2019, with a polarization between Milei and a candidate from the PJ, considered to have a medium probability.

• Another resembling 2023, with a three-way election among Milei, a PJ candidate, and another non-Peronist candidate, which is assigned a higher probability.

Both scenarios require PASO or PAS.

The other two alternatives are:

• A scenario similar to 2011, with a clear officialist superiority, Milei in first place, and a fragmented opposition, considered to have a high probability.

• Another resembling 2003, with strong fragmentation in a crisis context, which is assigned a low probability.

These last two scenarios do not require PASO.

There is much dialectic and speculation too early, as only one opponent is known so far: Milei. However, when debating the market and the economy, the corollary is that investors are dominated by the perception that doubts persist about the continuity of libertarian government policies.

Abroad, they are watching not only the interest rates in the United States for 10 and 30 years, a real red flag for Argentine dollar-denominated debt, but also the price of oil and the performance of Wall Street.

Locally, attention remains focused on the level of activity, Treasury accounts, BCRA reserves, the real exchange rate, and the evolution of the Di Tella Government Confidence Index.

Operators weigh that the Government is offering good coverage rates through the sale of dollar-linked bonds, compared to the alternative of buying currencies directly. They also observe better opportunities in short-term dollar bonds under local legislation.

The July CPI defined the new ceiling for the exchange rate band for September.

Additionally, they highlight the rise in forward rates from 11% to 15% as a reflection of electoral risk. For now, and depending on what the Di Tella index indicates, the recommended menus prioritize sub-sovereign bonds, without neglecting alternatives in corporate bonds, with yields between 7% and 8%, similar to a "B" rated credit in the United States.

Regarding equities, there is only apathy. If the climate improves, they estimate that there could be a near 13% upside potential due to reduced electoral risk.

Brazil: A Heavy Fiscal Legacy That the Market Still Downplays

However, the focus is not solely on next year's Argentine elections but also on those in Brazil, Israel, and the United States. Regarding the Brazilian case, during a meeting held in São Paulo, a financial mission from Washington outlined the following scenario: regardless of who wins, the next government will inherit an already established deficit, as interest payments represent 7.3% of GDP.

The projected global deficit for 2026 reaches 7.7% of GDP, and gross debt would increase from 96.5% to 102.3% by 2028. Brazil is trading with a five-year risk premium close to 124 basis points, according to the average from August, well below what such a debt ratio would suggest.

In a sample of eight Latin American sovereign issuers, the correlation between gross public debt and the five-year risk premium is only 0.33. Five of them have debt levels between 55% and 70% of GDP, and within that range, the premium fluctuates between 52 and 141 basis points. This means that debt levels are not sufficient to order risk premiums.

If those same countries are classified according to the average rating given by S&P, Moody's, and Fitch, the correlation is approximately -0.92, equivalent to about 16 basis points for each rating notch and capable of explaining 85% of the cross-sectional variation.

Rating agencies tend to arrive late, so their timelines are not necessarily the same as those of the market. A rating can compress risk when a fiscal situation becomes verifiable, that is, when there is a rule and an institution is obliged to report when that rule is violated, within an agreement that has survived a change of government.

The price of the premium reflects the probability that someone will notice that the deficit has deviated before the magnitude of the imbalance is fully incorporated.

In Brazil, Chile, Colombia, Mexico, Panama, and Peru, the average five-year premium is below 100 basis points, a level reached in just one-tenth of the months since 2010.

Between 2010 and 2013, that average was 120 basis points, with a dispersion of 20 points between countries. Since 2016, it has been at 129 basis points, but with a dispersion of 59 points. It is a similar average level, although with a cross-sectional difference nearly three times greater.

The compression came from a lower global factor, allowing for greater differentiation of the various carry trades. As the common component decreases, idiosyncratic factors begin to explain a larger portion of the price.

Brazil allocates each year the equivalent of 7.3% of GDP to interest payments, compared to 0.8% in Chile. This is cash that is transferred to local debt holders, on a stock that will continue to increase during the projected period.

Despite this, the external risk premium remains relatively stable, so the problem is never fully perceived as a sovereign crisis. Analysts do not expect the electoral outcome in October to produce significant movements in Brazilian spreads.

The two main candidates will inherit the same interest cost, equivalent to 7.3% of GDP, and neither has proposed so far to create an institution responsible for publicly reporting non-compliance with a fiscal rule. At a rate of 16 basis points for each rating step, a government that builds this institution today would receive a greater reward than at any other time since 2010.{#p-1787876817842-16414}

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