Wealthy Nations Daily Update - Mexico

On 17 February Banco de Mexico surprised the market with a 50 basis point intermeeting rate hike taking the benchmark rate to 3.75% and the central bank directly intervened in the currency market and announced that the Foreign Exchange Commission would suspend dollar auctions when the peso weakens by more than 1% from the previous day’s fix in favour of intervention on a discretionary basis.  The Central Bank Governor, Agustin Carstens noted that the depreciation of the peso and international market volatility had “increased the probability that inflation expectations are not in line with the consolidation of the permanent objective of 3 per cent.”

But the move was also a clear statement by the Mexican authorities that the recent weakness in the peso, which saw the peso dollar exchange rate weaken as far as 19.4448 intraday, had gone too far.  Shorting the Mexican peso has been a liquid way to short emerging markets but it got to the point that the currency was no longer reflecting Mexico’s fundamentals.  The central bank move has at least increased the cost of shorting the peso with the added risk of further unexpected intervention. The peso appreciated in response to this policy shift and is now trading at 18.0870 to the dollar at the time of writing.  Interestingly, and more likely a better reflection of fundamentals, the government bond market was much less affected with the local currency and USD Mexican 10 and 30 year bonds rallying year to date. 

The rate rise came in conjunction with Luis Videgaray, the Finance Minister, announcing budget cuts of 0.7% of GDP.  The MXN132bn (~USD7.3bn) of cuts is prudent, timely and ‘credit positive’ as, even although Mexico has in place oil hedges at USD49/bbl for 2016, if the oil price were to remain where it is the fiscal adjustment required in 2017 will be close to USD7.5bn.

Despite USD 2bn of foreign exchange intervention last week, Mexico has sizeable foreign exchange reserves of USD174bn; in fact reserves have remained stable since November last year and at the end of 2015 its reserves were just ahead of Germany in size.  Mexico is a ‘wealthy nation’ with net foreign liabilities of 39.5% of GDP using Stratton Street’s 2012 NFA estimates. Our cut-off for countries to be considered a ‘wealthy nation’ is net foreign liabilities of 50% of GDP; IMF research indicates levels above this threshold are associated with increasing risk of external crises.  But even ‘wealthy nations’ can be temporarily caught up in indiscriminate bouts of market volatility.  The World Bank notes that the 2013 Taper Tantrum “initially triggered indiscriminate capital outflows from emerging markets. Over time, greater differentiation emerged.” Countries that faced the greatest financial market disruption had “large current account deficits following a period of rapid real appreciation, modest international reserves, and weaker growth prospects were associated with sharper drops in capital inflows and disruptions in financial markets.” 

The use of unconventional monetary policy for an extended period of time has inflated asset markets.  Thus, the Fed starting to reverse monetary policy in December 2015, combined with a stronger dollar and still weak global growth has increased market volatility.  Moreover, markets are questioning the efficacy of using negative rates to try and sustainably boost aggregate demand.  Faced with this realisation a desire to de-risk has put ‘emerging markets’ under pressure from capital outflows, although it is the debtor nations with excessive net foreign liabilities that will ultimately come under the most pressure.

This backdrop favours positioning in long duration higher quality credits from ‘wealthy nations’ as yield curves continue to flatten.
 

Please read this important information before proceeding. It contains legal and regulatory notices relevant to the information on this site.

This website provides information about Stratton Street Capital LLP ("Stratton Street"). Stratton Street is authorised and regulated by the UK's Financial Conduct Authority. The content of this website has been prepared by Stratton Street from its records and is believed to be accurate but we do not accept any liability or responsibility in respect of the information of any views expressed herein. The information, material and content provided in the pages of this website may be changed at any time by us. Information on this website may be out of date and may not be updated or removed.

The website is provided for the main purpose of providing generic information on Stratton Street and on our investment philosophy for the use of financial professionals in the United Kingdom that qualify as Professional Clients or Eligible Counterparties under the rules of the United Kingdom Financial Conduct Authority (the "FCA"). The information in this website is not intended for the use of and should not be relied on by any person who would qualify as a Retail Client. Products and services referred to on this website are offered only at times when, and in jurisdictions where, they may be lawfully offered. The information on this website is not directed to any person in the United States. The provision of the information on this website does not constitute an offer to purchase securities to any person in the United States (other than a professional fiduciary acting for the account of a non-U.S person) or to any U.S. person as such term is defined under the Securities Act of 1933, as amended.

The website is not intended to offer investors the opportunity to invest in any Alternative Investment Fund ("AIF") product. The AIFs managed by Stratton Street are not being marketed in the European Economic Area ("EEA") and any eligible potential investor from the EEA who wishes to obtain information on the AIFs will only be provided with materials upon receipt by Stratton Street of an appropriate reverse solicitation request in accordance with the requirements of the EU Alternative Investment Fund Managers Directive ("AIFMD") and national law in their home jurisdiction. By proceeding you confirm that you are not accessing this website in the context of a potential investment by an EEA investor in the AIFs managed by Stratton Street and that you have read, understood and agree to these terms.

No information contained in this website should be deemed to constitute the provision of financial, investment or other professional advice in any way. The website should not be relied upon as including sufficient information to support any investment decision. If you are in doubt as to the appropriate course of action we recommend that you consult your own independent financial adviser, stockbroker, solicitor, accountant or other professional adviser. Past performance is not necessarily a guide to the future. The value of investments and the income from them may go down as well as up. An application for any investment or service referred to on this site may only be made on the basis of the offer document, key features, prospectus or other applicable terms relating to the specific investment or service.

Where we provide hypertext links to other locations on the Internet, we do so for information purposes only. We are not responsible for the content of any other websites or pages linked to or linking to this website. We have not verified the content of any such websites. Such websites may contain products and services that are not authorised in your jurisdiction. Following links to any other websites or pages shall be at your own risk and we shall not be responsible or liable for any damages or in other way in connection with linking.

By using this site, you should be aware that we may disclose any information that we hold about you to any regulatory authority to which we are subject, or to any person legally empowered to require such information.

This website uses cookies to improve user experience, by clicking the "I Accept" button below means you consent to the use of cookies on our website.