Bond Rally Shows Market Desire For New Leadership

Argentine restructured sovereign debt is rallying, with yields having fallen to their lowest levels since January on news that President Cristina Fernández de Kirchner has had to temporarily transfer power to Vice President Amodo Boudou due to health reasons. W hile reports indicate that the health issue is not critical, w e believe this market move illustrates the degree to which investors are hungry for a chang e in leadership in Argentina and ready to take signs of health problems as evidence that Fernández' role in politics is waning.

We have long argued that the October 27 midterm election will deal a blow to the ruling Frente Para la Victoria (FPV) bloc, signal ling a shift away from the interventionist policies of the Fernández presidency, and news of Fernández' health problems are likely to reinforce this view . E ven in the event that Fernández can recover and serve out her term until 2015, her party is likely to put increasing focus on finding a replacement , a process we believe will produce more moderate policies ( see 'Moderate Peronists Likely Empowered After Fall Election', February 22 ) . Yields on the global US$ 2033 restructured government bond have fallen from a recent high of 15.5% on August 30 to 13.3% at one point on October 8, and yields could continue to compress to the 12-13% range if a sooner-than-expected transition in power appeared increasingly likely.

That said, we remain cautious of Argentine sovereign debt, as long-term challenges remain. First, the country's fiscal picture is weak , and a fter posting the first primary budget deficit in over a decade in 2012, Argentina's government finances remain quite strained . W e believe its forecast for a 2.6% of GDP primary budget surplus next year is overly optimistic ; we forecast a 2014 primary budget deficit of 0.1% of GDP ( see 'Pre-Election Spending To Widen Fiscal Deficit', September 10 ) .

Yields Falling Despite Medium-Term Risks
Argentina - US$ 2033 Restructured Government Bond Yield, %

Argentine restructured sovereign debt is rallying, with yields having fallen to their lowest levels since January on news that President Cristina Fernández de Kirchner has had to temporarily transfer power to Vice President Amodo Boudou due to health reasons. W hile reports indicate that the health issue is not critical, w e believe this market move illustrates the degree to which investors are hungry for a chang e in leadership in Argentina and ready to take signs of health problems as evidence that Fernández' role in politics is waning.

We have long argued that the October 27 midterm election will deal a blow to the ruling Frente Para la Victoria (FPV) bloc, signal ling a shift away from the interventionist policies of the Fernández presidency, and news of Fernández' health problems are likely to reinforce this view . E ven in the event that Fernández can recover and serve out her term until 2015, her party is likely to put increasing focus on finding a replacement , a process we believe will produce more moderate policies ( see 'Moderate Peronists Likely Empowered After Fall Election', February 22 ) . Yields on the global US$ 2033 restructured government bond have fallen from a recent high of 15.5% on August 30 to 13.3% at one point on October 8, and yields could continue to compress to the 12-13% range if a sooner-than-expected transition in power appeared increasingly likely.

Yields Falling Despite Medium-Term Risks
Argentina - US$ 2033 Restructured Government Bond Yield, %

That said, we remain cautious of Argentine sovereign debt, as long-term challenges remain. First, the country's fiscal picture is weak , and a fter posting the first primary budget deficit in over a decade in 2012, Argentina's government finances remain quite strained . W e believe its forecast for a 2.6% of GDP primary budget surplus next year is overly optimistic ; we forecast a 2014 primary budget deficit of 0.1% of GDP ( see 'Pre-Election Spending To Widen Fiscal Deficit', September 10 ) .

Furthermore, we believe the ongoing legal battle between the Argentina government and ' holdout ' bond investors in the US presents substantial risk of a sell-off in these securities that could come with little warning . The current court ruling requires Argentina to pay the holdouts or lose access to US financial institutions in order to make coupon payments on the restructure debt, a decision that we believe could force Argentina to unilaterally change the jurisdiction of the bonds in question and trigger a technical default ( see 'Default Risk To Keep Yields Elevated', August 29 ).

The US Supreme Court has refused Argentina's first petition to appeal a lower court's ruling that it must pay holdouts, but t here are several additional steps before Argentina must actually decide between paying holdouts or entering a technical default on the restructured debt , including the decision of the entire Second Circuit Court of Appeals as to whether it will rehear the case, and potentially another Supreme Court appeal . These process es could play out slowly over the next year or more. However, the judges in question may decide that the decision must go into force while the appeal process is begin exhausted, a move that would significantly advance the timetable for a potential technical default. As such, we believe that major, market-moving decisions could come without much warning, a significant downside risk to the rally in restructured Argentine sovereign debt.

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Sector: Country Risk
Geography: Argentina, Argentina, Argentina, Argentina
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