Argentina's Shock Therapy and Angola's Breakup with OPEC

Hi all,

It is Christmas time🎄🎅🍷! Grab a cup of mulled wine, sit beneath Christmas tree , and enjoy our latest publication.

On behalf of the SovereignBeat team, we wish you a happy and healthy festive season! Our next publication drops on the first working Monday of the year, January 8th. Cheers to a productive year ahead!

In this ‘celebratory’ publication:

• Europe recorded its lowest inflation rate in over two years

• Red Sea crisis

• Argentina takes on ‘shock therapy’ measures

• Egypt’s tough choices on refugee acceptance and sterling devaluation

• Angola broke up with OPEC

Let’s dive in.

Markets Snapshot

Federal Reserve

• Fed officials, including Austan Goolsbee and Loretta Mester, caution against premature optimism on rate cuts, aligning with John Williams' view on the untimeliness of a March rate reduction.

• Nonetheless, swaps markets are currently pricing six interest rate cuts from the Fed next year, up from the three anticipated at the end of October. Both the 2-year and 10-year Treasury notes are steadily declining, affirming the market's optimistic outlook on the economy and the Federal Reserve's capacity to further alleviate inflation.

European Central Bank

• The Euro Area's annual inflation rate dropped to 2.4% in November 2023, the lowest since July 2021. The decline is attributed to slower price increases in services and food, along with a slight dip in energy prices. Core inflation registered at 3.6% YoY, marking the lowest figure since April 2022. Despite this, ECB President Lagarde suggested that inflation is anticipated to increase in December due to an upward base effect in energy costs.

• Eurozone government bond yields experienced a continued decline amid anticipations of rate cuts. Germany's 10-year yield dipped below 2% for the first time since March, while the spread between Germany and Italy's 10-year yields reached its narrowest point since June.

Equity Markets

• The S&P 500's seven-week bull run is contingent on forthcoming economic data, encompassing durable goods orders, personal consumption expenditures, and the final Q3 GDP estimate in the US.

Oil Prices

• Oil prices experienced a drop on Thursday despite geopolitical tensions, following Angola's announcement that it would exit OPEC (full story in the Geopolitics section 👇📜)

• Nonetheless, prices rebounded as a result of a series of attacks by Yemen's Houthi rebels on commercial vessels in the Bab-al-Mandab Strait. This prompted over 100 container ships to redirect their routes, circumventing southern Africa to avoid the Red Sea and potential assaults on vessels along the western coast of Yemen. Houthi rebels, aligned with Iran, attacked ships in response to Israel's Gaza bombardment. On Tuesday, the US announced its intention to lead a naval coalition aimed at protecting shipping in the Suez Canal.

Big Read - Global Finance

Will Shock Therapy cure Argentina's troubles?

Over a week ago, Argentina officially devalued the peso by 54%, introducing a series of emergency measures as part of President Javier Milei's shock therapy program. In our continuous commitment to provide a lot value to our readers, we have decided to present a detailed yet concise analysis of Argentina's current and compelling economic and financial narrative, shedding light on the big changes under the new president.

• Besides devaluing the peso, the central bank announced the adoption of a crawling peg regime, planning to devalue the peso's official rate by 2% per month. The the policy rate will be kept unchanged at 133%. The central bank also switched its benchmark interest rate from the 28-day Leliq rate at 133% to the overnight reverse repo rate of 100% amid an economic crisis. This move aims to simplify monetary policy amid an economic crisis but diverges from the country's IMF agreement, which requires monetary policy rate to exceed annual inflation.

• Additionally, Milei's new government aims to cut transfers to provincial governments, raise import taxes to 17.5%, and reinstate personal income taxes that were cut by the outgoing government.

• Revenue-raising measures are expected to contribute 2.2 percentage points of GDP, while spending cuts are anticipated to achieve 2.9 percentage points. These combined efforts aim to bring the overall budget close to balance next year and eliminate the estimated deficit of 5.2% of GDP.

Breakdown

• With a 54% devaluation, the official FX rate now stands at 800 per dollar, up from the previous rate of 391 (crazy, I know!). It will fuel inflation in the short to medium term, depressing domestic demand but supporting the fiscal adjustments. As painful as it sounds, it is an important step that needs to be taken to break the country out of the vicious cycle of never-ending increases in government debt, inflation, and sovereign defaults. Inflation persists as a symptom of underlying fiscal and external sustainability challenges, with the consumer price index rising by over 160% annually in November.

• Milei is keen to exaggerate the crisis, suggesting inflation could soar to 15,000%, ensuring the public grasps the magnitude of challenges. This approach is quite logical: gaining broad support may diminish if severe challenges arise during the implementation of crucial reforms; it is preferable to mentally prepare the country for potential difficulties in advance.

• It's refreshing to see Milei take a pragmatic stance, abandoning radical libertarian ideals like full dollarization and central bank closure. With Luis Caputo and Santiago Bausili at the helm of the Ministry of Economy and the central bank (BCRA), we can expect a commitment to macroeconomic orthodoxy in their policies.

• Devaluation and fiscal adjustment aim to curb imports and assist in rebuilding dangerously low reserves. However, the aggressive fiscal adjustment still poses execution risks amid a challenging political scenario, with Milei’s party lacking a majority in congress.

• A successful shock therapy measures could rapidly reduce inflation by late by 2025. However, achieving will decrease disposable incomes of households and increase poverty level in the short-term. That said, shock therapy is one of few limited options that Argentina have to tackle hyperinflation and overindebtedness. On the positive side, there are upside risks, presenting the potential for long-term and persistent growth that the country has been lacking for some time.

Geopolitics

Angola Quit OPEC!

• Angola has declared its exit from OPEC after 16 years of membership, citing a dispute over oil production quotas. The move comes as the cartel attempts to stabilize global prices. Luanda rejected a reduced output limit imposed by OPEC members reflecting the country's declining capacity.

• We delved into the captivating saga of Angola resisting Saudi-imposed production cuts here, followed by Angola's president meeting Biden at the White House two days later. Biden's declaration, "there’s no important country in Africa than Angola!" underscored geopolitics in full swing!))

• Angola's decision to leave OPEC raises concerns agian about the group's unity, but it is not anticipated to impact production outlooks, as the country has already been producing at full capacity and is unaffected by OPEC+ quotas. Angola's departure reduces OPEC membership to 12 nations.

• According to Bloomberg, the nation's output has declined by about 40% to approximately 1.14 million barrels a day over the past eight years, reflecting insufficient investment in aging, deepwater oil fields

Egypt’s Sisi Clinches the Thrid Term

• Egypt's President Abdel Fattah al-Sisi secures a third term with a resounding 89.6% of the vote.

• Notably, he secured his top position as a result of the 2019 constitutional amendment, which prolonged the presidential term from four to six years, enabling him to stand for a third term.

• This victory comes against the backdrop of significant economic challenges, such as escalating inflation and the looming prospect of additional currency devaluation.

Our thoughts

• Following the vote, economic decisions, potentially including a currency devaluation may finally follow. However, the dominant military-backed governing structure in Egypt is unlikely to undergo significant changes.

• Floating the Egyptian pound is a key condition set by the International Monetary Fund (IMF) under its current $3 billion Extended Fund Facility (EFF) arrangement. An outright free float exchange rate would result in a roughly 20% devaluation against the U.S dollar, leading to a significant inflationary impact. To mitigate this, the government might opt for more gradual and staggered devalutaion.

• Egypt is also under increased international pressure as displaced Palestinians gather at its border. Ongoing discussions involve a potential increase in the IMF's funding to $5 billion, contingent on Egypt accepting refugee resettlement. Despite initial government opposition, we anticipate that Sisi will eventually agree to a higher IMF disbursement and the acceptance of Palestinians. This comes as the country grapples with double-digit inflation, low reserves, and 30 percent of the population living below the national poverty line.

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Our Further Reading Recommendations

• How risk of Debt Distress has soared and the poverty rate has ceased to fall in the poorest countries (FT)

• Biden's Gaza Approach: Geopolitical and Internal Implications (FT)

Marry Christmas and Happy New Year 🌟🎊❄️🦌