300% Inflation and First Surplus in 16 years

Welcome back to SovereignBeat!

In this publication:

• Treasury Yields surge, rate cuts are off the table

• EU poised for June cut

• Yen hits 34-year low vs. dollar

• Russia defies sanctions, supplies record oil to China.

• Milei celebrates inaugural budget surplus, but road ahead is tough

Let’s dissect

Markets Snapshot

• Let's start from another important key findings from the IMF presented in D.C. a week prior, which wasn't covered in the previous edition of SovereignBeat. The fund warned of ongoing income disparities in Sub-Saharan Africa (SSA) amidst a gradual economic rebound, citing geopolitical risks, internal instability, and climate concerns. Despite a projected regional growth of 3.8% in 2024, up from 3.4% in 2023, and positive economic indicators like reduced inflation and increased international bond issuances by Ivory Coast, Benin, and Kenya, the IMF highlighted the widening income inequality, exacerbated by population growth and heightened political turmoil, which is denting invesor confidence.

  Nonetheless, in its forecast for SSA, the IMF projects a growth rate of 4.0% in 2025, driven by a surge in private consumption and investment.

Bond Markets

• US: Last week, US 10-year Treasury yields surged above 4.7%, marking their highest level since early November. This uptick coincided, or rather reflected, a shift in traders' expectations regarding the timing of the Fed's interest rate cuts, with the first reduction now anticipated by December. Moreover, traders started increasingly factoring in the likelihood of another US interest rate hike, with the options market indicating a 20% probability of such a move within the next 12 months. Although the prevailing scenario still favors interest rate reductions, this shift follows a mixed bag of economic indicators: while Q1 2024 GDP growth in the US stood at a modest 1.6%, the lowest since Q2 2022 and notably below the projected 2.4%, inflationary pressures persisted. The core Personal Consumption Expenditures index for Q1 spiked to 3.7%, up from 2% in the preceding quarter. Additionally, US jobless claims fell to a two-month low, underscoring the labor market's resilience.

• EU: In contrast to the FeD, ECB Vice President Luis de Guindos has indicated that an interest rate cut in June is likely to occur, provided there are no unexpected developments in the data leading up to that point. This anticipation aligns with market expectations, although the trajectory of interest rates after the June meeting is less clear. Guindos highlighted that concerns over services inflation, heightened US inflation, and geopolitical tensions contribute to the uncertainty surrounding future decisions.

• Another senior ECB official, Joachim Nagel, a member of the ECB Governing Council and President of the Deutsche Bundesbank, confirmed that the ECB remains non-committal about the trajectory of interest rates following a potential initial cut in June. While supportive of a rate reduction in June, Nagel, known for his cautious stance, emphasized that such a step should not automatically lead to further rate cuts.

• Japan: The yen plunged to a fresh 34-year low on Friday as the Bank of Japan opted to keep interest rates around zero to 0.1 per cent, resisting pressure to tighten policy and support the currency. In March, the central bank abandoned its negative interest rate policy, marking the first increase in borrowing costs since 2007. While not expecting to raise rates this week, the central bank faces a complex scenario with the yen's decline and signals from the US Federal Reserve regarding the need to maintain high interest rates to control inflation. Given this, the current market speculation suggests that the central bank may hint at further rate increases later in the year.

Commodity Markets

• Oil: Brent crude prices barely shifted , ending just 0.17% lower on Friday compared to the week before. Iran's foreign minister downplayed Israel's retaliatory strikes, causing drops in US treasuries and oil prices on Monday morning, followed by a rebound by the end of the trading week. The mix bag of economic data mentioned before suggests to market participants that the Federal Reserve is unlikely to cut interest rates soon, while ongoing geopolitical tensions are still influencing oil market sentiment. These two conflicting dynamics are expected to keep oil traders cautious.

• Turning our focus to regional markets and our perennial topic of Russia, sanctions, and its oil resources, we must report that despite challenges encountered by Russia's refineries, including struggles to recover from flooding and drone attacks from Ukraine, the country's seaborne crude exports unfortunately remained high in April. Even amidst escalating sanctions from the US, Moscow has managed to sustain its export levels to key clients like China and India with new traders appearing whenever an existing one attracts the attention of the US and the EU. Moreover, China's imports of Russian oil surged to the highest level in over 20 years, accompanied by record volumes of gold imports. China brought in 10.81 million tons of crude, approximately 2.56 million barrels per day, from Russia in March, marking the highest volume recorded since data collection began in 2004. These figures include deliveries via pipeline and shipment. The four-week average shipments to Asia, mainly to China and India, also remained close to their peak levels since June, at 3.33 million barrels per day.

Global Finance

Argentina Reaches First Quartertly Surplus

• In a televised address, President Javier Milei celebrated Argentina's first quarterly fiscal surplus since 2008, emphasizing his commitment to maintaining fiscal discipline throughout his term. The crisis-prone country posted a quarterly fiscal surplus of 0.2% of gross domestic product to start the year, as well as a third consecutive monthly surplus in March.

• Argentina managed to achieve the surplus by significantly reducing transfers to provincial governments by three quarters and halting nearly 90% of public works projects. The surplus was also bolstered by 300% annual inflation, which diminished the purchasing power of public sector salaries and pensions, resulting in reduced real spending and public investment and transfers.

• Since taking office, Milei has slashed the currency by over 50%, halved government ministries, scrapped numerous price controls, and initiated reductions in energy and transport subsidies. This week, Argentina's central bank slashed its key interest rate from 70% to 60%, marking the fourth cut since December as officials foresee a continued easing in inflation. In March, inflation decelerated for the third consecutive month, dropping from a 26% month-on-month (mom) increase in December, with consumer prices rising by 11% mom, slightly below economists' expectations of 12.1%. However, as already mentioned yoy inflation remains stubbornly high at 287.9%, reaching its peak since the early 1990s.

Our thoughts

• The new government's accomplishments, while significant, may encounter long-term sustainability challenges due to their reliance on short-term measures and the detrimental impact of high inflation on public spending power.

• He and his team will need to work hard to reduce inflation, stabilize public finances, and repair and keep afloat relationships with creditors such as the IMF. Additionally, another crucial aspect of his agenda should focus on strengthening the political groundwork for his party to secure more seats in the 2025 midterms. This is vital to ensure the passage of his omnibus bill — the comprehensive reform package presented by Milei’s government to move forward with massive economic, financial, labour and social changes that failed to pass committtee back in February.

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