Fiscal Decay, EM Parallels, and What’s Next for the Dollar | Nicolás Dujovne
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The ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough. Thank you. Let's close this door. Very pleased today to be speaking to Nicholas Duhovny, founder and chief investment officer of Tenec Asset Management. Nicholas was also the former minister of the treasury for Argentina between 2017 and 2019. Nicholas, welcome to Monetary Matters.

Thank you. Thanks a lot. It's a pleasure to be here today with you. Nicholas, I want to start by asking, throughout your career in Argentina, in Argentine financial markets, as well when you were working for the government of Argentina, just how much was the Argentine economy and Argentine financial markets and funding conditions affected by global conditions, and in particular, the U.S. dollar? Nicholas Eberstadt

I would say that always, always, because Argentina has a very tiny local capital market. So Argentina was not successful yet in building a local capital market with the size of the one that other countries achieve, like Brazil or Chile.

or many other EMBM economies that started with processes of stabilization. They became floaters. Inflation went down and eventually they started to replace the way in which both the government and the corporates financed themselves by replacing the usage of dollars by the local currency.

Then, of course, improving a lot the capacity to withstand external shocks because you don't have the balance sheet effect of all your liabilities, you know, mismatched with your flows. So for many other countries,

having the possibility of financing themselves in local currency was a major step that Argentina still has to do. I think that the major setback in that way, in that direction, occurred in 2008 when the

left-wing populist government, led by the Kirchner family, sees the pension funds.

Argentina has a pension fund industry that managed savings of the future retirees that started in 1994. So gradually that was becoming a major player, providing long-term investments to the private sector. So it could have acted as the seed for generating this big investment

local capital market, but in 2008, the government decided that I want to use these funds to finance my expansion of the budget without relying in external markets or without market discipline. So they seized

the local pension funds. They even didn't compensate for them. It was like an expropriation, I would say. And that was a major hit for having a large domestic capital market. So having said that, you know, in a country that

structurally had a fiscal deficit for many, many years. 2024 was the first year in many of Argentina posting a financial surplus and overall surplus on its budget.

But for many, many years, Argentina has a fiscal deficit. So the way to finance that was issuing dollar debt or paying the money, of course. But when we relied in the markets, you know,

We did so especially on external markets. So what happens in the rest of the world is very important for Argentina. So I told you the long story, but the short one is, you know, for Argentina, what happens abroad is very important. And so...

When you were minister of the Treasury for Argentina from 2017 to 2019, if I recall, that was a time when the Federal Reserve was gradually but steadily increasing interest rates. How did that impact your role as minister of the Treasury? And were you primarily focused on the issuance and maintenance of the debt or were there other macro prudential and financial issues?

the tasks that you were focusing on? The most important structural problem of Argentina was the fiscal deficit. And that fiscal deficit was generated by too high government expenditure.

For many, many years, Argentina had a very stable size of the government that was close to 25 percentage points of the GDP until, you know, the year 2002, 2003. Then we had populist administrations that almost doubled the size of the government expenditure from 25 to 42 in 2015 when President Macri took office.

So our diagnosis was, okay, we want to reduce the deficit in order to do that.

We need to bring down the government expenditure. And Argentina has already very high and distortive taxes, the way of bringing down the fiscal deficits is by reducing the government expenditure to GDP. And we were in that process. Actually, under Macri's presidency, government expenditure went down from 42% of the GDP to 36%.

But we were navigating that process when the Federal Reserve started to hike. And that occurred at the same time that Argentina suffered its worst drought in 50 years that shaved one third of our exports in 2018. So at that time, our decision was to go to the AMS and to secure a program

so as to finance the transition until we arrive to a lower level of expenditure and fixing our fiscal deficit. And we were in that process.

In 2019, we achieved primary equilibrium in our fiscal accounts, but we lost elections. So the new administration that took office at the end of 2019 decided to increase again the size of the government expenditure to print money. And so all the effort that was done between 2016 and 2019, you know,

was somehow worthless. But, you know, we planted the seed for the new experience that Argentina is now embarked with President Millet, which they're again fixing the fiscal as we were doing under Macri's presence.

Thank you. I want to say, currently, you're an investor in emerging markets, fixed income, and we will get into that. This is not going to be an Argentina-only conversation. But if I were to ask you, why is the inflation rate in Argentina, which had been as high as several hundred percent and now is down and is, quote unquote, only 50 percent, why isn't inflation in Argentina so high? And

If your answer is the fiscal deficit, why are there countries such as Japan and the United States and other nations that have very high levels of fiscal deficits but don't have high inflation? So first, both Japan and the U.S. have fiscal deficits.

But they still have demand for government securities as a way of financing the deficit. So it is not that they are financing the deficit by printing money that the group does not want. So eventually, if they persist in their deficits, they will

can derail this and of course, inflation will appear at some point. But up to now, both

US, Japan, and many other advanced economies, the European ones, are able to find a lot of demand for the government securities. They finance the deficit with bonds, not by a monetary printing. So as soon as they can maintain that, as they're perceived solvent in intertemporal terms by the private sector, they can avoid

the appearance of persistent inflation, even when they have fiscal deficits. Argentina is one of the countries with one of the worst track records in terms of debt repudiation during its history.

So the number of defaults that Argentina experienced in the last 100 years is only comparable to Ecuador and some other very small economies. So the demand for government securities is not as ample and limited as it is in the advanced economies.

At some point, for example, during the previous administration between 2019 and 2023, the administration of Alberto Fernandez printed the equivalent of 25% points of the GDP to finance the deficit with a monetary base that was roughly 8% of the GDP. So any arithmetics that you will perform, you know, that that

of course, means that Argentina was flirting with hyperinflation. And it was very close to experience one. In 2024, in 2023, inflation was north of 200%. We were close to entering into a hyperinflation. Only the decisive action of the new administration that took office in December 23 avoided Argentina experiencing hyperinflation.

hyperinflation. But the reason is that, you know, Argentina was persistently financing its deficits by a monetary printing rather than issuing debt because our history of defaults prevented Argentina of being a credible issuer of government debt.

And that's why Argentina needs, you know, to fulfill its contracts for many, many, many years, for 10, 20 years without a default as a way of recovering its capacity of permanently financing its deficits. We hope that we will not have a deficit again, but, you know, it is reasonable to think that if Argentina...

regains some credibility in very bad years, in years in which you have a shock, it is very likely that you will see tax collection coming down and you will see a transitory deficit that will be financed by the issuance of debt.

But of course, Argentina needs to regain credibility to finance its deficits by debt issuance rather than monetary printing. But that's a long process that will take a lot of time. Argentina still has a

is displaying 50% year-on-year inflation. If you go to the annualized three months, inflation of the last three months is 39%. It's coming down. But even when Argentina is not financing the deficit anymore with the central bank since the last one year, one year and a half,

Well, the monetary policy has lags. We are still digesting the excess of supply of pesos generated by the previous administration. But eventually inflation will continue to come down. But even when you stop printing money, relative prices still have to adjust in Argentina.

Non-tradable goods are still too cheap as compared to tradables. And as tradables are not as flexible to the downside, this relative price adjustment will be fixed with non-tradable goods growing, prices growing slightly faster than the ones of the tradables.

So eventually, you know, Argentina can achieve a one-digit inflation rate in a couple of years, if it persists in the actual policies. And that's the process that was observed in other countries like Peru, Brazil, Chile.

when they stabilize their economies in the 90s. So I think that, you know, it will take three, four years for Argentina to achieve a one-digit inflation rate, and that will be a success.

So you think Argentina could achieve a single digit inflation rate of 9%, 6%, maybe even lower? That would be wonderful over the next few years. That would be definitely a wonderful thing. Nicholas, you've got a lot of monetary nerds in the audience. I'm sure they're very curious. When you say monetize,

money printing. Tell us what you mean. In the United States, the Federal Reserve can expand the monetary base. The commercial banks also very involved in expanding the money supply in terms of making new loans, but also buying the securities that the U.S. government and other U.S. government agencies print.

When you talk about the government printing money, is it literally the Argentinian central bank just printing money that they don't even bear any interest? Or is it the government issuing short-term securities, three-month bills with interest rates, and then the central banks are buying it or the commercial banks are buying it or both? Tell us, get a little bit into the mechanics, please. On the mechanics, typically when you speak about monetary conditions in advanced economies, well...

You are speaking about the monetary multiplier and how the high power money is converting to M3. And that depends on the legal reserves of the banks or interest rates.

So, if you increase the opportunity cost of holding money, that will shift the size of M3 as compared to the monetary base. When I speak about monetary printing in Argentina, I'm speaking about something more brutal, which is the central bank.

financing the treasury with an expansion of the monetary base. So something much more primitive and brutal than when we speak about monetary conditions and monetary operations in the U.S. and what the Federal Reserve does. So...

So it's another step in terms of the impact of monetary policy on prices than, you know, moving the interest rate so as to act through the credit channel, which is basically the way in which we speak about monetary policy in advanced economies. In advanced economies, no, we speak about monetary conditions,

central banks respond to heights in or in the inflation or in the actual inflation or in the expected inflation by, you know,

tightening monetary conditions by hiking rates or by non-conventional measures to tighten monetary conditions. And that acts via the credit channel and via the monetary multiplier, by shrinking the multiplier when you create less secondary money by reducing

the size of the credit in the economy. In the case of Argentina, we were speaking about another story, by basically having new bills entering into the economy to finance the government. Thank you, Nicolas. I may end this conversation with a few more Argentina questions, but let's get to the heart of the matter.

your fund, Tenek Asset Management. You're investing in emerging markets. So I think you've got exposures to the credits, the rates, as well as the currencies. So just tell us a little bit about the remit of your firm. And also, as an emerging market fixed income investor, what's your

what is kind of your philosophy for success? For example, the legendary investor, Warren Buffett, if his success is, let's buy wonderful businesses at a fair price. Oh, and by the way, let's use insurance float in order to fund it at basically being able to borrow at negative interest rates. If that's his philosophy for success, what is your philosophy for success? Are you trying to get into emerging market currencies at the right time when inflation is going down, when the central bank is

cutting rates, raising rates? What are the other macro things that affect your judgment there? We found the TENAC late in 2019, some months after I departed the treasury of Argentina when we lost elections.

And our strategy started in May 2020. We do invest in three types of assets. We do credit, always in publicly traded securities. So we do credit in sovereigns, quasi-sovereigns and corporates. We do FX and we do rates, especially via swaps, via local swaps. And I would say that, you know,

So if I have to explain how do we think our process of investment. First, I would describe Tenac as an emerging markets macro hedge fund.

Immersion markets, of course, because we invest in immersion markets. Our low positions are EM. We can use the end position, some development market instruments to hedge our investments. But basically, we try to generate alpha investment.

and value through our investments in EM. We are a hedge fund because we can be long and short. We are agnostic to the index. It is not that we are an EMBI, the Immersion Marketplace Index of J.P. Morgan, just over-weighting or under-weighting some positions to enhance the market.

the return of the index. We intend to make money in every environment,

in periods of boom or periods of bust. We pretend to make money, so our benchmark is cash. So we work with a budget of volatility as the price that we are able to pay in order to have returns north of the budget of volatility that we have. And we are macro because we use macro in two ways.

The first one is for the top-down view of the strategy. So we permanently have a view on global growth, inflation,

effects have, you know, what is going on with the dollar against the majors or with the dollar against the EM currencies. Is the Fed ahead of the curve, behind the curve? So our assessment of in which part of the cycle we are will determine the overall positioning of our strategy. So in terms of how much duration do we want, how much beta

how much exposure to the markets. We don't invest in commodities, but indirectly, yes, because if we are going long, for example, Chile, of course we are exposed to the price of copper. If we are investing both in sovereign and in effects. So we have a view on commodities. So our...

assessment of global macro will determine duration, how much better do we want. So, how big is our net exposure to the market?

And we can be as 115% invested or just 0% or 10% or 15% as it happened during our history. We have been long, you know, 120% in our trade portfolio using some leverage. And, you know, at the end of 2021, we started to be, you know, concerned about the resurgence of inflation. We thought that the Fed was...

behind the curve and that inflation was going to appear with force. So we decided to shrink the size of our assets and to hedge them by shorting treasuries just to protect. So we went with negative duration into 2022. So that's one component, our macro view. And the second component is that

bottoms-up analysis, in which we are also macro guys. So all the day here in office, you know, all the team, we are permanently discussing countries. So we will discuss, you know, Argentina, Brazil, South Africa, Indonesia, and

We do proprietary research of every country in which we invest. We try to speak with authorities, with the IMF desk covering that credit so as to compare notes with colleagues, with the sell-side analysts. And eventually we have a view of the countries in the EM universe.

if we like the story and we want to play on the long side, okay, where? Is it the short part of the curve, the long end? Who

Or do we want to own a Quasi sovereign because it's trading wide to the sovereign so we can capture both the compression of the Quasi to the sovereign and the sovereign to the treasuries? So that's the other component. And with these two moving parts, the top-down view and the bottom-up, you know, we have a portfolio. And that portfolio typically, and we learn in this five-year process,

that is between 40 and 50 issuers. That's the number that balances our policy risks that entail some diversification because we have limits in terms of exposure per country, per, you know, we can speak about the risk policies, but it would be boring. But also, you know,

we have to couple our risk policies with our capacity of generating alpha. Should we invest in 400 positions? Well, we will be investing in the market. It will be very difficult to generate something different to the return of the EMBI with 400 positions because we will be investing in the market. So,

the number that we reached as the one that we own in the portfolio is between 40 and 50 issuers. And going back to the philosophy, our philosophy is

tenacity, and that's where the word tenac comes. It is not that we have a guru-style way of investing in which we have a view, okay, now inflation will come or deflation will come, so we go all in into this. No, okay, we have a macro view. That macro view is adjusted permanently, and then we have a portfolio to express that macro view.

And the portfolio of 40, 50 issuers is one in which we have a lot of turnout because once a position reaches the target, it's

is replaced, or maybe we don't like it anymore, or maybe we find something that is equivalent to one that we already have in the portfolio but consumes less capital or has less downside. So we are, you know, moving these positions permanently. And it's a very repetitive and boring process in which we are comparing, you know, credits all the day and

Is Argentina better than Ecuador? Is Cameroon better than Senegal? All those comparisons are very important for us to try to optimize our portfolio. And we rely a lot on quantitative instruments and models and a lot on a discussion amongst all the teams

in which we are trying to learn

I appreciate you laying that out. I know your performance has been quite good since inception, so congratulations on that. Thanks for that. Are you investing in so-called hard currency bonds, which over 100 years ago would be bonds that had to be paid back in gold? Now they're bonds that have to be paid back in dollars. So if you invest in Cameroon, if you invest in the dollar bond, you're not going to be worried about the currency depreciating, but if you're paid back in the local currency,

of Cameroon, then you're worried about that rate. So how do you invest in dollar bonds versus local currency bonds? And then also for the local currency bond portion, I want to introduce a concept of a forward price. So I prepared something, which is I just looked up the Chile one year interest rate, I think is 5%. Or if it's not, let's just say it is. The US interest rate for one year is 4%.

the treasury bills. So you could say, oh, that's so easy. I'm going to just buy Chilean pesos, the one year bill and earn a 1% greater carry than the 4% that the US yields. But of course, the market is priced so that the Chilean peso is going to depreciate 1%. That's like an arbitrage addition. So you're going to make money if the Chilean peso decreases by less than 1% or increases, and you're going to lose money if the Chilean peso decreases by 1%. So

how much of it really is a currency play? And when you talk about credit, if it's in a local currency, it's not so much that you're worried that you won't be paid back. It's that you're worried you'll be paid back in a currency that has radically depreciated against the dollar.

Yes, yes, of course. So measure our return in dollars. So our religion is to generate return as measured in dollar terms. Most of our investments are made in hard currency bonds, but we do invest in local currencies when we think that we can generate an extra return

by investing on those securities. And in some cases, we will hedge the local currency. And in some cases, we will not hedge the component because we are separating the trading in two parts. One is owning the interest rate of a local TV bill component.

that we think that we deliver strong returns and the other part is that we think that the currency will also perform better than the one implied by the forwards at which you will cover the FX risk. So if I can give you some examples of trades

that we have hedged or unhedged. For example, one of our biggest NAV, as measured by NAV positions, are the index bonds issued by, index to inflation bonds issued by Brazil, the 2050s, NTNBs. So those bonds are yielding

750 basis points above the inflation rate of Brazil, which is close to an all-time high in terms of spread because they just yielded this spread in 2014 when Brazil was facing a political crisis.

when Dilma Rousseff was ousted from the presidency, together with a sharp drop in the price of oil that impacted Brazil in the midst of the Lava Jato corruption scandal. So, you know, this spread is one that was only being, that traded only in the period of a big crisis.

But in this case, for example, we are hedging the effects. We just want to have the exposure to the spread. And we think that there's enough juice by owning the exposure to the spread and eventually that can generate very nice returns. We are also long-term

Egyptian and Nigerian one-year T-bills and hedged because at this level of the FX, we think that these yin's of 25% roughly, between 22% and 26% in both investments provide with an important buffer that the FX will depreciate less than that.

And we are also receiving the carry of being long the Turkish Lira in the two-year tenor that is yielding close to 40% annualized. Inflation rate now is 37%.

coming down. The target for the end of the year for the central bank is 24. It can be 24, maybe 26 or 27, but real rates are a very big buffer now in a country in which the central bank is targeting FX as a way to provide the disinflation that they want. The most important risk, as we saw

One month ago, it comes from politics. When the major of Istanbul was taken to jail one month ago, we...

We saw a lot of volatility in the Turkish Lira. So that's a reminder that investing in IEM has this tail risk that comes together with the high yields that it provides. So eventually, the challenge is to navigate these risks

high return assets without suffering too much of these tail risks in which you are exposed to.

So when you invest either in dollar bonds or bonds in the local currencies, tell us about the countries that issue dollar bonds. Do they do so because they want to do it or do they do so because they're unable to secure financing in local currencies? Perhaps that's what Argentina struggled through. And is it comparable to say that those countries are still on a type of gold standard? It's just the gold is the dollar standard. Most of the countries right now are

issue dollar debts, some of them because the size of their local capital markets is too small. So they have to rely on facing this mismatch of currencies between their flows and their stocks. And even the countries which buoyant and big local markets, you know, they issue dollar

A tiny part of the budget is financed by dollar bonds, so as to maintain a reference yield curve in dollars that acts as a liquidity provider and as a reference for the private sector issuing dollar bonds also. So in some cases, it's because it's beneficial for the economy as a whole for some countries.

is the result of having a very small domestic capital market in which you cannot finance your budget with long-term issuances in local currency. So many countries, even with small local markets, can issue at three months, six months, one year in local currency. But if you want to reduce, you know,

your risk of, your rollover risk and you want to, you know, extend the duration of your liabilities, well, you need to issue in hard currency. And to issue in hard currency in countries that are still unstable, you know, you have to go to hard currency and issue five years, ten years. The dollar market is the most important one. So,

Yes, it's different to the gold standard in terms of this technology.

These are, dollar is a fiat currency, it's different to the gold. But, you know, for the countries that are not the owners of the dollars, it's like going to the gold standard. But of course, the size of how much are you exposed to this balance sheet risk depends on, you know,

on the size of your deficit, on your capacity to start to rebuild your domestic capital market. And it's much different the share of dollar debt in terms of the as a percentage of the total liabilities of the EM countries today

as to the share of the dollar liabilities that the EM countries had in the 90s. In the 90s, with the countries still trying to stabilize and to bring down the inflation rate and to create their domestic capital markets, most of them were heavy issuers of FX assets.

debt that was called like the original zine, the original zine of many of the debt crisis that we see in Yen because, you know, Yen typically is a region that is intensive in producing commodities. The commodity prices are volatile. So FX should be somehow flexible and

and volatile. So if you have your tax collection linked to your domestic currency and all your liabilities linked to the dollar, eventually you can have a solvency problem. So that's the original sin. That original sin was basically resolved for most of the most important EM economies. So in the case of Brazil, right now, 90% of their

Liabilities are denominated in local currency. If you go to Indonesia or many other currencies, you will find the same. I don't know. And that's why you are seeing a much lower default rate also in terms of the sovereigns than the one that you had 30 years ago.

And so obviously, we're trying to talk about how you generating alpha and your specific views, and we're going to get into your specific views at this time of tremendous uncertainty. But would you say you're just a bull on the quote unquote beta of emerging markets debt? Because, you know, I interviewed Barry Eichengreen, the economist, about the paper he presented at Jackson Hole for the Federal Reserve.

And I just remember this chart sort of seared into my mind of debt to GDP ratios for advanced economies versus emerging market economies. And probably in the 1980s, I think it was emerging market economies that were

extremely indebted, but over the past 25 years, maybe advanced economies have increased their debt to GDP ratio. Whereas I believe emerging market countries have actually decreased their debt to GDP ratios, which might suggest that they're better credits. So for that reason or for other reasons, does that motivate you to be a bull just on the asset class of emerging market debt? Yes. Two issues there. First,

Yes, on the EM and developed markets, you know, debt to GDPs are around 100% on average. In EM economies, that ratio comes down to 55. So it's roughly half the size. But then, you know,

very important reason to be invested in EAM. If you look at the last 25 years of the returns of the different asset classes, you will find that in the last 25 years, the S&P was the best

returning asset class, roughly 10% analyzed. The second one was the EMBI, the Immersion Market Body Index, the hard currency index of immersion market economies as performed by JP Morgan with 8.5%.

But the difference is that the SHARP of the EMBI is much better than the one of the S&P. The S&P returned 10%, but with a much higher volatility than the one of the EMBI.

So I would say that in a global portfolio, exposure to emerging market debt should be a key component because the risk-adjusted return was one of the best among the asset classes that are available.

widely tracked in the investment universe. So that's the most important reason. You will find very consistent and interesting returns by investing in the app. And if you can enhance the return with an active strategy and generate alpha above

what is provided by a passive investment in the index. And of course, avoid the drawdowns that can appear in years in which rates in the US go up like in 2022. Loan only funds in 2022 fell on average 18%. And

It is not that the PMs, the portfolio managers of the long-only funds were bad PMs. They had a mandate being invested in a long-only strategy. They just tweaked, overweighed and underweighed some positions, but their mandate was to be invested. So if you can be invested in EM,

that has maybe the best sharp of all the asset classes in the last 25 years with a flexible way of reacting to the different environments, well, you are in a very good position of generating sound returns.

And Nicholas, how much are you looking at balance of payments statistics? Obviously, you're looking at the fiscal deficit for credits. But how much are you looking at the trade surplus and the services surplus, the current account surplus? Because a country can be running a very large fiscal deficit, but has a huge current account surplus. And theoretically, money should just be flowing back into the

the country because it exports way more than it imports. And how do you weight looking at that versus other more traditional macro things like inflation, growth, financial conditions and the like? Of course, it's a very important variable. And in every country in which we invest, we have an outcast of what is happening with the balance of payments. So we

We generate alternative shocks to the balance of payments with different prices of oil or the most important commodities of the country that we are analyzing. But, you know, contrary to what happens with the fiscal, in which, you know, basically, if you are in a good fiscal position, you are better than if you are in a bad fiscal position. On the balance of payments, you know, the conclusions can be more tricky because some countries...

Well, it can have a large current account deficit. Well, because of a virtual process in which the private sector is investing a lot. Because of what? Because the private sector is investing a lot. So if the private sector is embarked in a very strong process of investment,

even if the government is in equilibrium, you will have a current account deficit that, if it is being carried on the tradeable sector of the economy and will generate resources in terms of future exports in the future, well, that's something that you like. That's something that you want to happen. So the

causality in terms of, you know, balance of payments deficits and crisis is not as obvious as the one in the fiscal. So, so,

you can have current account deficits for very good reasons, and you can have current account deficits for very bad reasons. So if you are suffering a shock and your exports are falling and your current account widens, well, you are in a very fragile position because you have to finance that. And eventually that will drive to an FX depreciation, and that FX depreciation can cause inflation to go up.

inflation going up can generate, that the government can fall in popularity and lose the elections against the bad ones, or eventually, you know, many things can happen.

But so, of course, you have to focus a lot on the balance of payments, but the conclusions are not as in one direction like when you are looking at the fiscal.

And that leads us to another issue, which is, as people can guess, based on your prior role in the Argentinian government, you are an economist by training. Talk about the...

economic way of viewing the way, which has models where A implies B implies C implies D versus the real world where D may happen, but it happens for some completely different reason. For example, your equations may say that Columbia is going to be the place to invest, but someone could go on TV and say something and that effect of a

somewhat meaningless remark could affect the price, at least in the short term, 10 times more than your fundamental brilliant analysis. So talk, have you had to adjust and become a little bit more of a trader and an investor rather than an economist? And, you know, do you think if you still were, you know, pure economist, you think, you know, maybe you would expose yourself to some risks and lose money? But that's a nice part of this job, you know, because, you know,

We rely a lot in models to analyze the behavior of different assets and the way in which we should invest.

But at the end of the day, there's a human decision in analyzing the results of the models and discussing what can go wrong and if we have to invest the way which the model is telling us or not. And that's a very frank and candid discussion between the partners and the team here at PENAC.

So, you know, you have all the, for example, in the FX market, that's a nice example of a lot of automatized trading right now being carried by CTAs, you know, in which, you know, most of the players in the FX market use very similar models. You tend to, you know, analyze the short-term behavior of the effects of an X country by, you know,

using econometric models that will have as variables, for example, the rate differential between the country that you are analyzing as compared to the U.S., the behavior of the relevant commodity of that country, how the equity market of that country is doing as compared to the S&P, and some exogenous variables like the 10-year yield of the U.S., and the sovereign spread of the country that you are analyzing. So more or less these variables will explain

the short-term behavior of, and we flash you like a fair value of where the effects should be trading now as compared to the actual price. So there's a lot of automatized trading on using this type of models. But then, you know, then comes, you know,

the human part of investing. At this point, if you perform all these models for many countries, for many EM economies today, you will find a lot of short opportunities being flashed by the models. The models will be telling you that you have to go short, you know, a wide variety of currencies. But this is occurring at the same time

in which the U.S. exceptionalism is being challenged. The share of investments by the very large pools of capital in the U.S. as compared to other countries is being rediscussed.

And that's something new. So, eventually, the share of the market cap of the US at 60-something can go back again to 40-something in the next few years. And should that happen, eventually, the dollar will weaken for reasons not captured by the models.

And that's something that is occurring right now against the measures. But, you know, eventually after the spike of volatility fades, that can happen again also against the EM currencies. And that is not captured by the model. So, you know, there's a two-way process in which you use the models. Then you have to think on, you know,

other variables that are not captured by the models and, you know, decide. And that's, you know, the most interesting part of this. The way, the part in which, you know, you have to think deeply about, you know, trends and where you, how do you want to build your portfolio. So you say the U.S. could go from 60 to 40. I think you mean the U.S. stock market could go from 60 trillion to 40 trillion? And speaking about the share of

of the US market cap in terms of the total market cap of all the equity markets. So right now it's close to between 60 and 65. But not long ago, in 2018, it was 45. But then we had all the boom of technology, especially developed in the US.

Most of the expansion of the...

valuation of companies, of publicly traded companies occurring in the U.S. and that generated the expansion also of the participation of the U.S. equity market as compared to the rest of the world, I guess, you know, China and Europe especially. Well, will that persist with all the uncertainty being generated by the U.S. policy? Well, I don't know. Those are things that

you should plug you into your investment decision process. So it's not that I'm doing a forecast. It's just...

an example of things that should be considered as part of the investment process. You wonder whether the US stock market cap as a share of total global stock market cap is 60% might go down to a historical level of 40%. And I imagine that would coincide with a weakening of the US dollar. As we've seen, these things tend to be de-correlated. What we've seen is

In the last two months, in January, the dollar index was close to 110. Now it's 100. So we saw a sharp depreciation of the dollar, contrary to what was expected prior to Trump winning the presidency. But again, in the early 2000s,

the US dollar against the DXY was straight at 80, not at 100. So again, it is not a forecast, but the

depreciation of the dollar is a process that can last for many, many years if this US exceptionalism is questioned. How do you interpret the recent weakening of the dollar? You said the dollar index 110 to 100 is over 50% Euro and then it's got some yen in there as well. So those are developed market countries, not the emerging markets mostly that you invest in.

So, number one, why do you think that's been happening? And then also, how has your world emerging markets currencies fared against the dollar? Have they also been strengthening against the dollar or have they been staying flat? The recent underperformance of the dollar response to a long term downturn.

It changed in the long-term view in terms of how much can diverge equity valuations in the US as compared to other countries. Should the US persist in raising the average tariff

for imports from, let's say, 3% to 20%, well, productivity in the U.S. will fall. That's a process that is slow, but eventually will occur. And the...

the response to that in terms of the equity valuations should be there. So maybe some market participants are anticipating that and hedging that by increasing their exposure to other markets in which they will not see this falling productivity that eventually we will see in the US. Selling dollar assets, the rest of the world selling dollar assets. Yes. And in EMFX,

Up to now, we've seen a rebound in most of the FX rates of EM. So after some sell-off in the worst period of volatility around Liberation Day, we are seeing EM currencies recovering from the lows that we saw at that time.

I understand your argument about productivity. Tariffs, if the U.S. puts it on the rest of the world, will lower U.S. productivity. But in the short term, won't the... Let's say if trade between China and the United States goes to zero, we will have no imports from China. We will have no exports to China. But our imports from China were way higher than our exports. So our net exports will stop being a negative number that's dragging on GDP. So do you think that...

short-term, it could cause US GDP to actually go up? Or is my argument kind of weak for other reasons? Well, the theory predicts is that, you know, imagine in two countries' world, you raise country A, raise the status, you have a positive impact in GDP because production

in country A goes up so as to replace imported goods, which now are more expensive. Then you have a fall in productivity. And so eventually, after some period, the effect on growth of hiking tariffs is undetermined because, you know, you have a short-term effect of... But

I don't think that you will have this short-term spike in production in the U.S. by an import substitution because, you know, the U.S. is not prepared to produce the stuff that you are, you know, not importing from China, especially, or from other countries. That's a long-term process in terms of reallocation of production

of some manufacturing activities that were situated in other countries. And in order to see that increase in growth because of this import substitution process, well, it has to be perceived that the increase in tariffs is more or less permanent. So you can see some investment flowing into the new activities that will be developed to

to substitute imports. And in my view, this process was so disorderly that it's not generating the credibility so as to generate the associated investment process of bringing back to the US the activities that you are taxing from other countries. So

What I think is that the U.S. will grow much less than what was expected to grow at the beginning of the year. You know, most of the forecasts for U.S. growth in 2025 were close to 2.8%.

I don't think that it's very likely that the U.S. will grow more than 1.2, 1.3 this year. So the impact of the announcements was not positive for short-term growth. And in the long run, in my view, the impact would be much, much worse because of

of the inefficiencies that we generate. Going to tariffs of 15, 20% with the size of the scope of globalization that we are experiencing is not the best alternative for your country.

And what's your view of the US dollar, let's say over the next year, or you can choose a different time horizon as this tariff uncertainty plays out. Are you a bull or a bear on the US dollar relative to developed market countries and then relative to the emerging market currencies that's upon you swimming? Well, especially against developed markets, I may bear on the dollar because I think that the Fed will have to cut rates

maybe three or more than three times this year. So rates in the U.S. will go down very fast in the second half of the year in my view, and that will be the most important determinant of a weekend of the U.S. dollar. Eventually, after the volatility changes,

is reduced and this new environment of the US growing less is digested, EGM currents will do pretty well, and especially high yielders. You have countries with interest rates that are still very, very high because they have idiosyncratic reasons

for fighting the inflation rate with very high rates. So that's the case, for example, of Brazil or Turkey, Egypt, Nigeria, Kazakhstan, Uzbekistan, you know, countries in which interest rates are very high that can enjoy nice appreciation of their economy.

effects in this environment. So would you say you're bullish on emerging markets and you're maybe hedging less than you normally would? Are you taking more risk than you normally would? We are gradually increasing our net exposure. We went to, you know,

inauguration day and to liberation day with a very light exposure, a very light net exposure in the portfolio just to protect us. And that's how we navigated the waters in the fourth quarter last year and this first quarter. Fortunately, the strategy yielded good results and we are positive in

in the first four months of the year, in a very volatile period. But now we are taking advantage of, you know, the widening in spreads that occurred in April. So we are adding some positions that we do like. We think that, you know, the spread compression will be seen in the second half of the year. But, you know, we are, you know,

collecting on things that we think are distressed now and that we can harvest on the second half of the year. And just quickly, what type of countries are you looking at there? There are different types of stories out there. For example, we are doing the local currency in Egypt.

We like the hard currency ones of Colombia because they're trading too wide for political reasons, but north of 500 basis points. We like Colombia. We like the long end of Pakistan. We like the long end of South Africa, of Israel, Hungary, Romania.

And we also like the spread widening that occurred in Sri Lanka,

Argentina, Angola. So we are also taking positions there. And Nicholas, as you're trading the markets, is there anything unusual that you're seeing that you don't normally see? For example, if I imagine I asked you, instead of an emerging market fixed income investor, you were an investor in the US treasury market. I asked that question to you on April 7th when you had some very strange things, swap spreads widening out, very, very volatile moves in the supposedly safest...

market in the world, the US Treasury market. I imagine that you would have lots of things to say. Anything from your world that just seems not a little off, but just a little unusual? I would say that it was very unusual to see equities and treasuries going down in April. That was very unusual with all

as many other participants wondering, was that part of the basis trade or were the Chinese government dumping US treasuries? But that was very, very unusual. Now the most unusual thing that we are seeing is the resiliency of EMFX, even with this volatility.

Meaning that something is going on in terms of the positioning of investors out of the US dollar. Something is going on with the dollar assets that is generating flows to other types of assets that are historically perceived as more risky, but at this point we are seeing

Investors taking positions in EM even in a period of volatility. And that's because we think that there's a reduction in the exposure to the US that this has been channeled to EM. And are you seeing that in the price? Is the price telling you that? Or are you seeing that in fund flows, which come out a little bit later, or both? Yeah.

Flows are strangely positive in environments like this. Flows used to be negative.

So first our flows and then our prices. So we expect to see some rebound in prices in the next few weeks or months. Wait, sorry. Flows to emerging market index or flows to the dollar? Sorry, I wasn't clear with my question. Flows to EM funds. Flows to EM funds. Yeah, but so our flows...

Is money coming out of the dollar? Are you seeing that in fund flows that people are taking money out of U.S. dollar assets and putting that into Peru or wherever? Money is fungible, so it's tough to say. But our guess is that there's some reassessment in terms of exposure to the U.S.,

And Nicholas, you said it's unusual that the US stock market sells off along with the US dollar. Normally during a period of turmoil, the US dollar strengthens against other currencies because the rest of the world's capital markets, they run to safety. And that's a feature of the dollar having the reserve currency of the world and us being an advanced market and the most advanced capital market. It is more often in emerging markets, I believe, that the local currency weakens during turmoil.

Is it true that that's a characteristic of emerging markets that during turmoil your local currency weakens against other currencies? And if so, do you think that is the US becoming more like an emerging market? It will take a lot of time, but eventually, if you persist in broad policies, you can finally get there.

The U.S. should pay more attention to the fiscal deficit. The fiscal deficit in the U.S. is clearly unsustainable. The unsustainability of the fiscal deficit in the U.S. was masked by the one-off inflation that appeared after COVID that generated some stability on the debt-to-GDP ratio

just because of the unexpected inflationary shock that was provoked during COVID. But during the next few years, if the U.S. does not fix the fiscal, you know, eventually that will generate a sharp increase in debt-to-GDP. And, you know, we are seeing some impact of that already. You know, real rates in the U.S. now are...

Verify. If you decompose the 10-year yield of the US Treasuries at 4.3, the verifications are showing that 2.5 percentage points of that 4.3 is explained by inflation expectations, the 10-year inflation expectations.

But the remainder, close to 1.7, 1.8, are real rates, which are very, very, very high as compared to the recent history of the U.S., especially with an economy that is not buoyant. So those real rates in an economy that is not investing that much

is showing that some fiscal premium is embedded in those real rates and that eventually that will generate a lower investment than the one that the U.S. would have had with a much better fiscal position. So, you know, coming from Argentina, you know, we've been there. My advice is, you know, focus on the fiscal, fix it. You know, that's the best.

policies that the US can pursue for promoting long-term growth rather than messing around with that, which is nonsense. To the question, is the US financial market and economy exhibiting characteristics that indicate a little bit more like a traditional emerging market? It sounds like your answer to that question is maybe. Could you just elaborate on that? And also, could you say it in your own words rather than responding to my question?

Clearly, the U.S. is still a developed economy. But if this policy uncertainty and this fiscal position is maintained for many, many years, well, clearly, the U.S. will lose the opportunity

the status, the dollar will lose the status of the reserve currency of the world. That will be a challenge. You still have a lot of time. You still have a lot of time, but it is clear that you already have effects of not attacking the problem today in terms of long-term growth. So,

I would not be, you know, catastrophic in terms of, okay, now the U.S. became an EM currency, an EM market economy. That's not true. But if the U.S. persists in the policy mistakes,

in terms of tariffs that is occurring right now and does not fix the fiscal, eventually in 10 years we'll be speaking about another type of economy. So there's a risk there, but we're still far off. Yes, yes.

Thank you, Nicholas. I want to return asking about how Argentina is impacted by tariffs. I believe Argentina actually has a trade deficit, a current account deficit, I think, with the United States. So President Trump, through President Trump's eyes, he clearly thinks that when other countries have a trade surplus with the United States, that is a quote unquote ripping us off, that

that actually Argentina is in a somewhat good place that the U.S. has a surplus with Argentina. And therefore, Argentina will probably have a ceiling of a 10% tariff that it currently has now. In early July, the reciprocal tariffs will go up on other countries that run surpluses with the U.S., but not in Argentina, not on other countries that have deficits, like I believe the U.K. and Australia, maybe. Yeah.

So do you think Argentina actually is going to be a relative winner from these tariffs? And not that it's going to win, but that it's going to lose less than other countries. And then also talk about the trade bloc within Argentina and other countries and how there may be some negotiations going on there. Yeah. You have to decompose this into parts. One is the direct impact of tariffs of the U.S. with Argentina. And the other part is the trade.

the impact of the new U.S. policy in global growth and U.S. growth. So on the first part, well, Argentina was punished with just 10% tariff. You know, we've been taxed with the

with the lower bracket of tariffs of the rest of the blocs. But since Liberation Day, the trade bloc to which Argentina pertains, the MERCOSUR, started negotiations with the U.S. so as to extend, you know, a very important part of the positions of trading goods between the MERCOSUR and the U.S. So eventually, eventually,

this can lead to an average tariff of close to 3-4% at the end of the process. That's very similar to the tariffs that Argentina and the Mercosur had prior to the increase in the tariffs mandated by the U.S. But the fact is that if this trade bloc can have now

just a 3% tariff and the other blocs maintain a minimum of 10, well, in relative terms, there will be some deviation of commerce from other purchases that historically the US performed in other markets to the Mercosur. So Argentina, Brazil, Uruguay and Paraguay, which are the components of the Mercosur, can be relative winners of this negotiation.

Of course, then you have the secondary effect, which is that the U.S. will grow less and that the world will grow less. That means that global trade will be growing less than prior to this environment. And that's negative. But, you know, if you put all in the mixer, you know, Argentina can be a relative winner.

of these negotiations. Nicholas, what have you made of President of Argentina, Javier Millet? What have you made of his economic policies? How are you gauging their consequences? And what does it mean in the economic history of Argentina?

Basically, Argentina had a long-standing fiscal problem generated by the excess of government expenditure. This administration is very well focused on resolving the fiscal problems of Argentina. In the very first year of the Milet's administration, the fiscal deficit went from close to 5 percentage points to zero.

just one year. So that's remarkable. That's remarkable. And together with that, the government is taking steps for normalizing the FX policy by lifting capital controls. That's being done very gradually. I would have preferred the government to move more rapidly on this, but they choose a very gradual path to remove capital controls.

But, you know, eventually this combination of policies in which Argentina is gradually becoming a floater, you know, a country with an independent central bank, with a floating exchange rate regime plus fiscal equilibrium, is what Argentina needs and what can deliver prosperity for the Argentinians in the next few years.

And Argentina has a lot of natural resources that are underexploited, like, for example, in mining, in which, you know, with the same geology than Chile, we produce, you know, just 5% of what Chile produces in terms of mining. So, you know, it is very likely that we will see a sharp pickup in mining activity in Argentina.

Argentina is doing very well in increasing its oil production. We have a very productive, non-conventional oil basin called Vaca Muerta in Argentina that is generating a strong increase in our oil exports year after year. So, you know, prospects for Argentina are, you know, very, very bright if the government...

persists in the actual policies, and especially, you know, if a pro-capitalist government is re-elected in 2027. It can be Javier Millet or other candidate with a similar position.

policies. The very big drama that Argentina suffered in the last 20 years was the appearance of this left-wing populist movement called Quechua Rismo that basically destroyed the economy. It was something very unusual to see a macroeconomic homicide like the one that we saw in Argentina, in which the government expenditure was almost double in 80 years, from 25 to

close to 42. And correcting that is, of course, costly in the short run. And the challenge is to do that without losing the elections. In 2019, we lost the elections. So I expect that this administration or something similar can win the 27 elections and to maintain the course.

Robert Leonard : Monetary homicide, that's a very, very strong language, but I'm sure you use it seriously. The Argentinian stock market has performed very well. And I know in dollar terms it's performed well. So in the Argentine peso terms, it's outperformed even inflation and the depreciation of the currency.

Tell us, what do you make of the rapid increase in the Argentine stock market? And even though your fund does not invest in stocks or very little in stocks, it's fixed income. Do you have a view that you're willing to share? Companies in Argentina were trading at very, very depressed levels. It was an asset that no one wanted to touch. And, you know, in the last one year and a half, you know,

companies, the blue chips in Argentina return close to 200% in U.S. dollars.

Now, you know, most of the normalization occurred and, you know, for the rally to be sustained, what you need is that, you know, the EBITDA as measured in U.S. dollars continue to deliver in the next few years. And in my view, that will occur.

So it is very likely that in companies related to the energy sector, to banking, the level of profits measuring US dollars can grow at the rhythm of close to 20-25% per year.

because we are departing from very low levels and as the economy is being liberalized and, you know, the economy is enjoying this remonetization process in which deposits are growing fast, you know, banks will do okay. Energy companies are increasing their production at a very fast pace. So it is very likely that the equity market can do okay. But of course,

The rally that we enjoyed in the last two years cannot be repeated because it was departing from zero to something more normal.

To the extent there have been positive consequences you talked about of the delay of cutting government expenditure and that resulting in economically good things, inflation going down and the like, how are you gauging the risk of negative consequences? For example, I think when the Soviet Union collapsed and Russia reprivatized its economy, it was a very, very negative, negative thing.

What's different about this reprivatization that's more positive? And to what extent do you think there are risks there that it could be less positive going forward? You know, Quintino, most of the state-owned companies were privatized in the 90s. So it is not that we're going to see a process of privatization as the one

that was seen in Russia and countries that exited the Soviet Union. So the case in Argentina will be more like one in which the private sector can enjoy a healthier environment rather than a process of privatization.

That makes sense. Nicholas, thanks so much for being so generous with your time and insights here on Monetary Matters. It's been a real pleasure. Any final words for us before we close? It was a pleasure, Jack. I really enjoyed listening to your podcast. So being here for me was really an honor. So thank you.

A real pleasure speaking with you. The honor and pleasure was very much mine. Thank you again, Nicholas. A reminder to everyone watching to subscribe to our YouTube channel, The Monetary Matters Network, and leave a rating and review on your podcast app, whether that's Apple Podcasts, Spotify, or something else. Thanks again for everyone for listening. Until next time. Thank you. Just close this door.