The Daily Update - Mexico setbacks and resilience

Brexit’s running for the most fruitless trade talks seems to have a contender in the Tratado de Libre Comercio de América del Norte - or more commonly known, to those of us not in the Spanish speaking world, as the North American Free Trade Agreement (NAFTA). The good news for Mexico (and for the US and Canada) is that at least NAFTA negotiations can be extended - as they were yesterday, to the first quarter of 2018. On news of this, the Mexican peso has rallied almost 2% from its weak point a couple of days ago. The prior 7% depreciation of the peso over the past month was a sharp retracement of the bullish sentiment the markets had during the first half of the year; and amongst various causes was triggered by Trump’s characteristic uncompromising and hard-line position on NAFTA.

Recall that following the election rhetoric concerning NAFTA and relations with Mexico, the peso weakened as far as 22 to the US dollar. As these were assuaged the peso surged 25% in the first half of 2017, hovering between 17.5 and 18 in the third quarter, making it one of the best performers. So the 7% clawback is not just due to the deterioration of trade negotiations but also the withdrawal of carry trade activity, where the rising volatility has made high rates less attractive. Also fallout from the recent earthquakes, including halted oil refining in some facilities, will have had some negative impact on the currency. As such there is ongoing concern for peso weakness even while few NAFTA developments are expected in the coming weeks and months.

As the fourth round of NAFTA negotiations ended yesterday it was clear that the previous December target was unfeasible considering the “strong differences that remain” and that the “new proposals have created challenges”. The agreement pertains to $1.2 trillion in annual trade between the US, Canada and Mexico: particularly vulnerable is the auto industry which has various back-and-forths between Mexico and the US across the various production stages. Mexico arguable has the best source of cheap labour for such production with an autoworker’s salary less than $4 per hour; that is just 12% that of an average worker north of the border. This is one of the major sticking points with the US obviously wanting to sign a series of international labour agreements to increase the minimum wage of autoworkers.

Relating to earthquake damage, yesterday Mexican President Enrique Pena Nieto estimated reconstruction costs to be in the realm of 48bn pesos (~$2.5bn). But that doesn’t account for other elements of lost productivity. For example, Pemex’s and Mexico’s largest refinery at Salina Cruz had been offline since electrical systems were damaged. The plant seemed to be relatively resilient considering it was near the epicentre of the earthquake. But the company stated, “When the quake struck, the turbogenerators were turning normally and suffered some damage.” This week Pemex resupplied the site with two new electric turbo generators (capable of generating 70MW!) allowing the refinery to resume operations. With recurring aftershocks since the September 7th earthquake the company assured that “new preventive actions have been implemented to guarantee safety and the future start-up of the plant”. The restart of the facility will come as welcome news as the Salina Cruz refinery has the capacity to process 330,000 barrels of crude per day.