Dollar-Peso Woes Re-Hit Mexico, with a Vengeance

What does Trump have to do with it? 

By Don Quijones, Spain & Mexico, editor at WOLF STREET.

Mexico may be home to one of the more stable economies of Latin America, but the peso holds the dubious distinction of being the worst performing currency of 2016. There are two main reasons: first, the ongoing concerns about the ability of state-owned oil giant Pemex to service its gargantuan debts; and second, the currency’s role as a general proxy for global financial risk, which is clearly on the ascendance.

As the world’s most traded emerging market currency, the peso is often prone to steep ups and downs. However, in recent months, the currency’s movements have been even more volatile than usual. From October through February, the peso plunged 33% to a historic low of 19 pesos to the dollar. It prompted the Bank of Mexico to unleash a surprise rate hike in a desperate bid to smoke out currency speculators.

For a couple of months the intervention seemed to have worked, as the peso floated back up to 17 pesos to the dollar. But at the beginning of May, the trend reversed. In just six weeks, the peso lost 10%. It currently trades at 18.95, a whisker’s breadth of setting a new historic low.

Things could be about to get even uglier, thanks largely to political developments north of the border. As investors grow increasingly spooked over the prospect of a Trump presidency, more and more of them are hedging against such an outcome by shorting the Mexican peso. As Bloomberg points out, there is no shortage of reasons why the currency would fall — and fall quickly — following a Trump victory in November:

From seizing remittances to pay for a wall on the U.S.’s southern border to renegotiating the North American Free Trade Agreement to stepping up deportations, the presumptive Republican candidate’s proposals would hit Mexico’s economy hard if enacted and curb the steady flow of money into the country that supports the peso’s value. Even some of Trump’s policy flirtations that are wholly unrelated to Mexico — such as restructuring U.S. debt if needed and re-examining trade with China — would hit the peso because of the Latin American nation’s close ties to its northern neighbor and the way traders use the currency as a proxy for global risk.

“The only thing you are certain of is that if Trump wins, the Mexican peso will be weaker,” said Dirk Willer, a strategist at Citigroup in New York.

This could be particularly bad news at a time when the foreign-denominated corporate debt held by Mexican companies continues to scale unprecedented heights, after ballooning 18% between between March 2015 and March 2016. This trend is not just a result of the weakening peso. As we reported in August 2015, many companies continue to take advantage of exceptionally low interest rates in places like the U.S. and Europe. This trend has, if anything, accelerated.

“We are seeing growing leverage and more and more bond issuances in foreign currency, none of which should come as a surprise,” says Héctor Romero of Signum Research. “Interest rates on dollars decreased sharply after the 2008 crisis and Mexican companies were quick to take advantage of the cheap financing conditions. However, nobody foresaw the full scale of the peso’s depreciation against the dollar over the last year and a half.”

Corporate debt in dollars, euros, and yen may have become farcically cheap in recent years, thanks to the rampant interventions of central banks, but as emerging market firms are discovering, it can be a lethal trap.

As the peso swoons against the dollar, the dollar-denominated debt held by Mexican corporations with peso-denominated operating income becomes increasingly difficult to service.

This is not a problem for companies that operate predominantly in dollars, such as the mining groups Peñoles and Grupo Mexico, for whom all their sales are dollar-denominated compared to 83% and 90% of their liabilities, respectively. Nor is it much of a problem for the bakery giant Bimbo, whose biggest market is the US, or the Petrochemical conglomerate Mexichem.

But many other Mexican companies are beginning to learn the perils of stacking up on foreign-denominated debt. They include the retail and banking group Elektra, Cemex, ICA, Coca-Cola Femsa, Televisa and América Móvil, all of whom have borrowed heavily in dollars while operating almost exclusively in Mexican pesos or other Latin American currencies. In the case of ICA, once Mexico’s biggest construction company, the situation has become so grim that it has stopped paying its providers and defaulted on millions of dollars of debt payments. As Reuters reports, the firm has struggled with a hefty dollar-denominated debt load and insufficient new work.

To compound Mexico’s peso woes, production costs for many manufacturers are rising speedily as inflation rears its ugly head. Production costs increased at an annual rate of 5% in May, almost double the official inflation rate (2.6%). Particularly hard hit is the nation’s manufacturing industry which is already on the sharp end of a consumer slowdown in its largest export market, the U.S. In addition, firms now face the prospect of rising prices for many of the components they import from overseas.

As Mexicans well know, once inflation starts to build, it can be difficult to stop. And if what Bloomberg asserts is true — that investors are increasingly hedging the risk of a Trump presidency by shorting the already beleaguered peso — Mexican companies and the Mexican economy as a whole could be in for a very tough ride during the second half of 2016. By Don Quijones.

Could the “Tequila Crisis” happen again? The IMF is worried. Read… The Big Mac Peso-Dollar Blues in Mexico

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  11 comments for “Dollar-Peso Woes Re-Hit Mexico, with a Vengeance

  1. Bobo says:

    Mexico used to be almost a closed economy before NAFTA, few imports and heavy import tariffs. The Mexican economy and the peso seemed to collapse almost with regularity in those years. Mexico might be due for a currency crisis soon, with surging interest rates the main solution. Current interest rates in Mexico are probably too low to prevent flight into the dollar.
    Richer people put their money into real estate now, but values are already quite high in many cities, higher than comparable properties in the US in many cases. In the past a currency collapse always brought values back into line.

    • Petunia says:

      You always hear immigrants say they are saving to go back to the old country and live like kings. This should be a good time for Mexicans with dollars to go home. Or, investors to get that vacation property.
      I remember only a few years ago the rate was about 9 pesos to the dollar. How motivated are sellers?

  2. Ptb says:

    It’s pushing 19 again. ….if it breaks 19.4, it may go a run.

  3. John Doyle says:

    Mexico is Monetary sovereign. The government could buy the debt, just like the fed bought the bank debts in 2008. Exactly the same. Off balance sheet and no one much the wiser. Definitely no taxpayers involved.

    • Wolf Richter says:

      If it prints pesos to buy its peso debt, watch the peso lose half its value in six months. An emerging economy has zero wiggle room for this nonsense. The Fed can do that for a while without having to face the music. The Bank of Mexico will immediately face the music.

      And even if it wanted to, it can’t print dollars to buy its dollar-denominated debt. That’s the problem with Mexico. The Tequila Crisis was caused by Mexico’s dollar-denominated debt that it couldn’t service anymore.

      • Tim says:

        Almost all the Fed created money for buying treasuries and MBS is still sitting at the Fed, as excess reserves, it actually hasn’t gone into circulation. Inflation in the finance sector hasn’t been completely created directly by Fed ‘printing’ money.

        This is the question that some doom sayers pass over, how money that hasn’t left the Fed, has caused asset inflation. It has allowed the finance sector to rationalize upping the offer on all kinds of financial assets, that the Fed never bid on. The captive Fed bid that lifted MBS and treasuries stopped some time ago. It’s really the private sector that has done it. Captive investment funds, bond funds, and others have gone along with the charade, instead of applying discipline, since it’s OPM, other peoples money.

        And now Draghi with ECB monetary insanity is creating capital flight from NIRP, that helps put a bid under US financial assets. Mexico cannot get this level of bid support. And some other cbs have put a bid under US assets like the SNB. SNB buying US stocks – are they crazy?? It’s like foreign cbs are being run from Washington, since these kind of policies are helping prevent the USD from falling from the massive trade deficit.

        And so this a central question, if the Mexican cb creates pesos and buys Mexican public debt, does the money go into reserve accounts at the cb that can’t leave the cb (excess reserves)? or does it go into accounts that can go into circulation? The Fed has the ability to ‘sterilize’ their monetary creation, to some extent. And US dollar and treasuries get the flight to safety, that Mexico can’t get. I doubt that foreign cbs will do anything to support the peso, totally different situation from the USD.

      • nick kelly says:

        To add a needed note of levity- apparently North Korea for one does print US$.
        The recent security features in US bills may have been aimed at sovereign counterfeiters.

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