Short-term interest rates soar to 87%! Argentina’s currency crisis triggers cash shortage

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Argentina is facing a severe currency crisis, and the government’s efforts to defend the peso’s exchange rate are exacerbating the country’s cash shortage, pushing short-term interest rates to a record high of 87% and dealing a further blow to an already fragile economy.

On Wednesday (October 8), yields on Argentina’s locally issued Lecap bonds maturing November 28 soared from 74% on Tuesday to 87%, a significant rise from 51% at the end of last week. According to two people familiar with the matter, the Ministry of Finance has sold dollars for a seventh consecutive trading day, spending at least $320 million.

President Javier Milei’s government has recently fought on multiple fronts to prevent a depreciation of the peso, including reimposing certain foreign exchange controls and selling dollars in the futures market. However, the more the government does to support the peso, the more apparent the unsustainability of the current exchange rate level becomes.

The immediate impact of this currency crisis is being seen in the bond market. According to Paula Gandara, Chief Investment Officer of Buenos Aires-based Adcap Asset Management, dollar selling and election worries have heightened bond market volatility, and the 2035 bonds dropped by more than one cent after the government’s continued injection of dollars into the FX market.

Government Fights on Multiple Fronts to Stabilize Exchange Rate

In recent weeks, the Milei government has acted on several fronts at once to prevent peso depreciation. The government reimposed some foreign exchange controls and sold dollars in the futures market.

However, the more the government does to support the peso, the more unsustainable the current exchange rate seems.

After the Central Bank spent $1.1 billion of reserves last month to support the currency, it has recently been relying on Ministry of Finance funds to keep the exchange rate stable. In the past seven trading days, the Ministry’s total dollar sales reached about $1.8 billion.

According to Argentina’s agreement with the International Monetary Fund, the central bank can only intervene if the peso breaks through a set trading band.

Santiago Resico, an economist at one618 brokerage, said:

"The market seems to be pricing in a change in the exchange rate regime after the elections, which means the closer we get to election day, the greater the pressure on the exchange rate. The fact that the Ministry of Finance is selling a large amount of dollars every day clearly doesn’t help."

Political Considerations Under Election Pressure

Milei wants to avoid peso depreciation because this would drive up inflation before the October 26 midterm elections. The election involves half the seats in Congress, and Milei needs more support in both houses to advance his most challenging free-market economic reforms.

At the beginning of September, Milei suffered a heavy defeat in the Buenos Aires provincial elections, the economic crisis deepened, and corruption scandals also affected his close associates.

Although US pledges of assistance stemmed a wave of selling, they failed to reverse the downturn. According to media reports, IMF Managing Director Kristalina Georgieva said Wednesday she expects a decision soon on a new aid package.

Barclays economist Ivan Stambulsky stated in a report to investors last week that the currently most popular baseline scenario assumes the government will receive 34% to 37% of the vote in the upcoming election. In this scenario, Milei is still likely to govern through veto powers and executive decrees.

The Market Calls for Exchange Rate Liberalization

The extreme volatility in the bond market reflects investors’ doubts about the current policy path.

After a strong rebound on Monday, the 2035 bonds fell by more than one cent the following day. Bonds sold off across the board for much of Wednesday, but picked up in afternoon trade after IMF head Kristalina Georgieva commented that a decision on new aid was imminent.

David Austerweil, Associate Portfolio Manager for Emerging Markets at VanEck, New York, said bluntly:

"The market wants them to devalue the currency and let it float freely. No more bands, no more intervention. This will happen sooner or later."

On Wednesday night, the House of Representatives approved legislation limiting the use of presidential decrees. After some amendments, the bill has been sent to the Senate for final approval, which may further limit Milei’s ability to push reforms in the latter half of his term.

Risk Warning and DisclaimerThe market has risks, investment requires caution. This article does not constitute personal investment advice, nor does it take into account individual users’ specific investment goals, financial situation, or needs. Users should consider whether any opinions, views or conclusions in this article are appropriate for their particular circumstances. Investing accordingly is at your own risk. ```