Next week Mexico’s central bank, Banxico, is expected to step up rate cuts with a 50bp reduction in the targeted overnight interbank rate. This is a faster pace of easing from the last two cuts of 25bps in August and September this year from the peak in rates at 8.25%, and will bring down the policy rate to 7.25%. Low domestic and global growth, peso stability and a narrowing of the Pemex and fiscal risks we feel will enable this action.
The system utilised by Mexico is very similar to the US Fed, where the board of governors meet monthly and decide the level of interest rates. However, this faster pace of easing could hurt the peso’s stability and in time could create the opportunity for us to add peso exposure, on further weakness; especially with the relatively high-interest rates which could come down to about 6% during this easing cycle. Core inflation has remained sticky at 3.68% year on year and so there is adequate room for these cuts to help the struggling economy.
We have exposure to Pemex and some Mexican government bonds mostly denominated in US dollars, although we do hold a Mexican government bonds denominated in euros, so any peso weakness won’t affect us directly. Our bonds are all long-dated but we should benefit from the actions of Banxico as they strive to improve the economic fortunes of the Mexican economy.
Staying in the region, for the second time in a row, the world’s major oil companies snubbed Brazil’s deepwater auction, forcing government officials to reconsider the bidding process that has up till now given state run Petrobras what some think is an unfair advantage. Out of five blocks offered yesterday, four went bid-less, with the fifth going to a consortium of Petrobras and China’s CNODC, a unit of China National Petroleum Corp, and even that only achieved the minimum bid. Not that anyone was shocked with that particular bid, as it’s a field Petrobras already operates in.
However, it’s not only Petrobras’ special rights that have discouraged the energy giants, it’s also the eye-watering costs, even for the oil majors. The problem is the oil is located in Brazil’s pre-salt area. Although there is said to be over 50bn barrels of oil, it lies below 2kms of a thick layer of salt, at a water depth of between 2 and 3kms, hence drilling will require massive long-term investment compared to other fields. As one oil chief put it ‘the rewards are enormous, but then so are the risks’.
The government does appear to be rethinking the whole process though, calling the current idea of production sharing ‘awful’. As Paulo Guedes, the Economy Minister put it, ‘We undertook an enormous challenge to, in the end, sell to ourselves. We spent five years talking about it. We made a spectacular effort, studying, debating — and in the end it was a no-show’. No Samba then Paulo.