2024-06-22 03:00:42
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Newly elected Mexican President Claudia Sheinbaum faces a tough battle to lure investors back into the country’s financial markets amid concerns about controversial judicial reforms and the prospect of higher borrowing costs.
The peso has stabilized after a sharp sell-off following the election, and it briefly gained this week as Sheinbaum appointed a pro-business economy minister.
But given the huge victory of Sheinbaum’s Morena party, fund managers are reluctant to bet again on the Mexican currency, which was dubbed the “super peso” earlier this year.
“I don’t think the peso will recover,” said Edward Al-Hussainy, head of emerging market fixed income research at Columbia Threadneedle. “The assumption that Sheinbaum will pursue softer, more pro-business policies is unrealistic. She ran on a very, very positive mandate.”
“We reduced our exposure to Mexican credit and foreign exchange assets in the run-up to the election and we reduced our exposure more after the election. The election did have an impact on our fiscal outlook.”
Despite Sheinbaum’s promises of fiscal discipline, the Mexican peso last week fell to its lowest level since March 2023, days after she said she would move forward with her party’s plan to enact sweeping judicial reforms, firing 1,600 independent judges and replacing them with elected ones.
Mexican officials’ efforts to calm investor concerns have had little success. On Thursday, Sheinbaum named six cabinet members, including business-friendly Marcelo Ebrard as economy minister, who will be responsible for attracting foreign investment and promoting industry and trade. The peso strengthened after the announcement but later gave up some of its gains.
Karl Schamotta, chief market strategist at Corpay, said it will be difficult for markets to assess the impact of incumbent President Andrés Manuel López Obrador’s reform agenda in the coming months, but expected Sheinbaum to give her team a more reasonable voice.
“Their voices appear set to grow louder as Mexico prepares to move away from the personality cult-driven politics of the AMLO era. As this process unfolds, the peso could move further higher,” Schamotta said.
But even after the modest recovery, Mexico’s currency is still down about 8 percent against the dollar from its pre-election level and a far cry from its strong gains earlier this year.
The reaction did not spread to currency markets: Investors demanded a record 10.6% yield at an auction of 30-year Mexican bonds on Tuesday.
The election shock comes as Mexico’s economy has begun to slow. Citigroup economists this week cut their GDP growth forecasts for 2024 to 1.8% from 2.1% and for 2025 to 1.2% from 1.5%. They also raised their inflation forecasts, albeit modestly, and predicted the peso will weaken further to 19.74 per dollar next year from 18.22 currently.
Sheinbaum, a leftist former academic and longtime political activist, closely followed López Obrador’s rhetoric and policies during her campaign and after her victory. Her projected supermajority in Congress and her support for proposed judicial reforms have fueled perceptions that she will adhere to López Obrador’s more radical line.
“Sheinbaum’s reassurance efforts, while stopping the sell-off, don’t get us back to where we were,” said Kit Juckes, an analyst at Societe Generale.
The sharp fall in the peso is partly due to a reversal of a popular foreign exchange strategy called the carry trade, in which investors borrow the currencies of countries with low interest rates, such as Japan or Switzerland, to invest in higher-yielding assets such as Mexico. Mexico’s hawkish central bank, which raised borrowing costs sharply in advance to try to tame inflation after the coronavirus outbreak, currently has a benchmark rate of 11%.
After the Mexican election, “you saw the peso plummet and the yen rise,” Schamotta said. “It was clear that people were fleeing to safety and unwinding speculative positions.”
Sam Lynton-Brown, head of global macro strategy at BNP Paribas, said the yen/peso trade has been popular and lucrative in recent years, with returns of more than 50% from the beginning of 2023 to May 2024.
But investor appetite for such investments depends on a relative lack of volatility in currency markets. And given how bumpy Sheinbaum’s reform agenda may be, few analysts expect a full return of investor enthusiasm for the peso.
“The idea of the carry trade assumes that you have a stable political and economic framework where markets can try to exploit large carry differentials,” said Shahab Jalinoos, head of G10 FX strategy at UBS.
“Once you start taking large idiosyncratic risks, it’s a different story. You’re taking money to take risks that you might not be willing to take.”
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