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, Raging Bull-Shit.
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