In a world immensely exposed to Mexico’s debt and peso.
By Don Quijones, Spain & Mexico, editor at WOLF STREET.
Mexico’s economy has excelled at two key things over the past two decades: opening itself to global capital and attracting foreign direct investment, in particular from American businesses. But those two things could soon become its Achilles heel, especially with Donald Trump seemingly determined to renegotiate, if not scrap altogether, the document most responsible for transforming Mexico into an industrial powerhouse and one of the world’s most open economies, the North American Free Trade Agreement (NAFTA).
Thanks to NAFTA, Mexico has never been so dependent on its northern neighbor. The U.S. accounts for 80% of its exports, 49% of its imports and 60% of all its foreign direct investment. In fact, so intertwined is Mexico’s economy with its northern neighbor that it just became the second biggest exporter to the U.S., overtaking Canada for the first time ever, reports Bloomberg:
Shipments from Mexico totaled $245 billion in the first 10 months of the year, according to Commerce Department figures released Tuesday, ahead of Canada’s $230 billion. If the trend continues, it would be the first time ever the U.S. bought more imports from its neighbor to the south. The two countries ended 2015 tied in exports to the U.S.
The trend of catching up to Canada puts China and Mexico as the top two exporters to the U.S. just as Trump prepares to take office in January, reflecting the strong pull of lower cost jurisdictions for the U.S. economy.
When it comes to low-cost production, few countries can hold a candle to Mexico, whose sub-$4-a-day minimum wage is one of the lowest in Latin America. The country is also the region’s most investment friendly economy, according to the global benchmark of investment standards, the World Bank’s Doing Business report.
But that hasn’t stopped foreign investors from putting their expansion plans on hold since the election. One of Trump’s most popular campaign promises is that he would make it much more costly for U.S. industry to outsource to countries like Mexico and China. The president elect has already brokered a “deal” with United Technologies Corp’s Carrier unit, whereby Indiana taxpayers pay $7 million to Carrier, which will still send hundreds of jobs to Mexico, but 850 fewer jobs for now than before this “deal.”
“If he puts an import duty on Mexican goods, it’s going to be a total disaster,” said Maurizio Rosa, CEO of Codan Rubber Mexico, a maker of hoses for the auto industry with annual sales of some 200 million pesos ($10 million).
The Trump effect has already taken a toll on Mexico’s funding capacity, following Fitch’s recent decision to downgrade the country’s economic outlook from stable to negative. The US rating agency cited a number of reasons, including Mexico’s slowing economy, rapidly expanding public debt and the trials and tribulations of its shrinking energy giant Pemex. But the two most important factors, it said, were price volatility (i.e. inflation) and widespread uncertainty about how a future Trump administration would approach US relations with Mexico.
It’s not just Mexican investors that should be concerned. As Bloomberg reports, the world has never been as invested in Mexico as it is today. Foreign investors hold around $100 billion of Mexico’s local-currency government debt, the most for any emerging market economy. That’s almost 20 times what it was 20 years ago. To further compound matters, the Mexican peso is among the world’s most widely held currencies and is commonly used as a proxy to hedge risk in less liquid markets.
But now the world has become so exposed to Mexico that any rapid sell-off of the country’s assets could have very ugly repercussions far beyond its immediate borders. “A broad stability of the peso is a global public good,” said Alberto Ramos, the chief Latin America economist for Goldman Sachs Group Inc. in New York. “It has repercussions and implications across the financial system and even areas of the financial system that are not directly related to Mexico.”
But it may already be too late: foreign money began to pour out of the country months ago, according to Mexican daily La Jornada, citing data recently published by the Bank of Mexico (often endearingly referred to as Banxico). A total of 132 billion pesos ($6.47 billion) worth of Mexican bonds were unloaded by foreign investors during the first eleven months of 2016. This gathering exodus of foreign investors is one of the major causes of Mexico’s crumbling currency.
As the peso weakens, fears continue to rise over the prospect of one of Mexico’s traditional bugbears — galloping inflation — rearing its ugly head. The five-year breakeven rate, a bond market measure for cost-of-living expectations, has jumped to 4% from 3.2% before the U.S. election. As Bloomberg reports, November’s reading was the highest in almost two years, and Citigroup Inc. expects prices to increase 4.8% next year, the most since 2008.
In an effort to tame price rises Banxico is expected to raise Mexico’s benchmark rate by as much as half a percentage point next week, to 5.75%. It would be its third rate hike this year.
But as was the case with the previous rate hikes, it will be events beyond Mexico’s borders, in particular in Washington and New York, that will ultimately dictate the future movement of Mexico’s currency. If the Federal Reserve decides to raise rates, not only will the peso continue to slide against the dollar, but foreign investors are much more likely to be lured north of the border in the pursuit of rising US Treasury yields.
This is precisely what happened in the run up to the Tequila Crisis of 1994-95, which created (with apologies to Ross Perot) a “giant sucking sound” of money out of Mexico that put some of Wall Street’s finest, including Citi and Goldman Sachs, at enough risk to where the IMF and other entities engineered a bondholder bailout. And this time around, too, the collateral damage will almost certainly not be contained to Mexico’s economy. By Don Quijones, Raging Bull-Shit.
The peso crisis could trigger next dollar-debt crisis in Mexico. Read… Financial “Hurricane” Trump Is Approaching Mexico