(Bloomberg) -- Argentina investors are, once again, running for the exits after being caught off guard by the nation’s notoriously complicated politics.
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Assets slumped Monday after Sergio Massa, the economy minister turned presidential candidate, pulled off a surprise comeback in a first round vote. After a dismal showing in August primaries, he took roughly 37% of the ballots Sunday, forcing a second-round with runner-up Javier Milei, the firebrand libertarian who got around 30% support with nearly all votes counted.
The nation’s dollar bonds — trading between 20 and 27 cents on the dollar — were the worst performers in emerging markets Monday. Notes fell across the curve, with bonds due 2030 declining as much as 3.3 cents before paring losses. An exchange-traded fund tracking Argentina stocks dropped 2.3%.
The selloff comes as investors brace for a runoff they say is the worst possible scenario for the country’s battered assets. On the one hand, you have Massa, who’s revved up spending in the run-up to the election, adding pressure on an economy headed for its sixth recession in a decade, with negative net reserves and no access to global capital markets. On the other, you have Milei, an outsider with little political support whose main plan for the country risks further stoking inflation that’s already running at 138%.
Read More: Massa Gains Upper Hand on Milei as Argentina Heads to Runoff
For Alejo Costa, the chief strategist at BTG Pactual in Buenos Aires, bonds could drift even lower on bets the government will feel empowered to maintain its economic policies for longer, fueling further inflation and putting more downward pressure on the peso.
“The government will throw everything and the kitchen sink at it ahead of the runoff, extending recent policies,” Costa said. One possibility is trying to win over voters with a fresh round of spending the government can ill afford, he added.
In recent months, Massa has granted welfare checks to workers, bonuses for retirees and tax cuts for 99% of the population, the latter of which is expected to cost the government about 0.8% of GDP, or about $3.5 billion at the official exchange rate.
Kimberley Sperrfechter, Latin America Economist at Capital Economics, said the economy minister turned presidential candidate is likely to increase what she called “pre-election fiscal giveaways” ahead of the runoff — which will increase the country’s vulnerabilities and make an eventual economic adjustment “even more painful and, potentially, more disorderly.”
“Whoever next resides in Casa Rosada will face the tall order of pulling Argentina’s economy back from the brink – something even a more market-friendly administration will find challenging,” she said.
In addition to the extra spending that’s likely to come ahead of the Nov. 19 runoff, investors will also try to assess where backers of third-place candidate Patricia Bullrich migrate to. Markets had hoped for a stronger showing by Milei or Bullrich, believing either one would pursue a more aggressive economic overhaul as president.
“The market’s preferred outcome would have been strong popular support for Patricia Bullrich and her team of experienced orthodox technocrats,” Graham Stock, senior EM sovereign strategist at RBC Bluebay Asset Management. “Massa and Milei both herald greater uncertainty.”
Read More: Inflation Raging at 130% Is Pushing Argentina Down Radical Path
The result of the Sunday vote signals a wide-open race. Some analysts see Massa as the favorite, pointing to his ability to build support — Massa got almost 3 million votes more than he did in the August primary, compared to Milei’s gains of about 500,000.
“Milei’s confrontational style did not help in bringing new votes since the PASO elections earlier this year. This suggests a slight bias towards Massa,” Dirk Willer, Citigroup’s head of global macro and EM strategy, wrote in a note.
Milei won a following with a radical proposal to use the US dollar as the country’s official tender, scrapping the peso altogether — the world’s worst-performing currency, which he says “nobody wants.” For years, Argentina has restricted the daily moves of the peso in a bid to control rising consumer prices, a strategy that has spawned a dozen different FX rates, all of which are largely disconnected from the official rate.
The move is seen as high-risk, with some economists warning it could fuel even more inflation. His strong showing in the August primaries caught markets by surprise, with investors rushing to sell the bonds amid concerns about his ability to govern.
Read More: Baffling Argentina FX Rates on Borrowed Time as Election Nears
“Milei should probably be viewed as a very slight favorite despite failing to gain traction since the primaries,” said Patrick Esteruelas, the head of research for Emso Asset Management. “He should still be the candidate best positioned to capitalize on the enormous discontent with the political establishment and the current economic context.”
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“Massa’s first-round lead gives him incentive to postpone realigning the official peso rate. A new interest rate hike is a possibility — with few dollars in the reserve coffers, the government may want to raise funding costs to reduce the demand for greenbacks and ease the pressure on parallel markets.”
—Adriana Dupita, Argentina and Brazil Economist
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Massa’s comeback staved off speculation the government would devalue the peso immediately after the Sunday vote — a repeat of what it did following the primaries, when it let the local currency slip by 18% just as trading opened. Pressure on peso futures, which had been building for the past few weeks, is falling sharply, strengthening to 670 from 790 in end-December contracts.
“While the result suggests that the markets will lower the probability of a larger FX depreciation in the coming days, all the other measures will likely worsen, making an already difficult situation worse,” Morgan Stanley analysts led by Fernando Sedano wrote in a note. “We expect bonds to revisit recent lows.”
--With assistance from Selcuk Gokoluk, Srinivasan Sivabalan, Kevin Simauchi and Walter Brandimarte.
(Updates prices in third paragraph)
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