Uncertainty would be costing the government dearly

MEXICO CITY (El Universal).— Faced with the financial turbulence that came following the elections, investors are asking the federal government for higher interest rates when lending money, analysts told “El Universal.”

The Treasury Department had to commit on Tuesday to pay an annual rate of 10.83% to place 14.5 billion pesos in bonds that must be paid off in three years. This is the second highest yield in almost 22 years. This operation is part of the primary auctions that the Federation carries out every Tuesday, through the Bank of Mexico (Banxico), to offer debt instruments and finance the fiscal deficit.

“On the secondary market, where these instruments are resold between investors, the same three-year bond reached more than 11% this week,” says Investing.

Luis Gonzali, Vice President and Director of Investments at Franklin Templeton Mexico, compared the episode of post-election volatility to that observed in October 2018, when the project in Texcoco was cancelled.

“In this environment, investors should be given a greater reward. We saw rate increases, especially on long-term bonds; for example, the three-year bond and the Udibonos, which means that the prevailing uncertainty is costing the government more,” said the expert in an interview.

In the secondary market, the 10-year bond, the best reference for investors, reached a rate of 10.82% this week, the highest interest rate in 19 years, since April 2005, while the 30-year instrument set a record of 10.92%.

At the end of the day, Gonzali stressed, lenders demand higher yields for the risk they perceive, which means that the government ends up paying higher rates and that puts pressure on public finances to cover this premium.

“This situation reflects the perception of market participants regarding the risk their capital is running, which is why they are hedging at a higher rate,” he added.

Capital flight

Luis Gonzali said that markets do not like uncertainty or not knowing the rules of the game. However, he ruled out an abrupt capital flight due to political noise.

“We are quite far from that scenario,” said the vice president and director of investments at Franklin Templeton Mexico.

Strong reaction

For CitiBanamex analysts, national and global markets have been forceful in their reaction to the statements of President Andrés Manuel López Obrador on the approval of judicial reform.

“If the President insists on forcing a hasty legislative authorization of reforms next September, it would structurally weaken the starting conditions for Claudia Sheinbaum’s government, as well as the prospects for materializing the historic opportunity that nearshoring presents,” warned the bank’s experts.

For his part, MetAnálisis analyst Gerardo Copca pointed out that higher interest rates not only mean that the federal government must pay more interest for issuing debt, but also companies and individuals who have variable-rate loans.

Valmex’s Deputy Director of Debt Markets, Yazmin Matus, said that next Tuesday the government will auction 30-year bonds, so investors will surely request higher rates.

“The prices requested will be aligned with the rates on the day of the auction, which is next Tuesday,” he said in an interview with “El Universal.”

To determine the yield that investors who purchase these financial securities will receive, Yazmín Matus recalled that various variables are considered, such as similar rates in the United States and other countries.

In his opinion, bond rates will move based on hard data at the national and international level. In order to cover debt interest, the government proposes to allocate 1.26 billion pesos this year. However, for every 100 additional basis points in the expected rates, the payments and refinancing costs of the obligations that are regarding to expire increase by 30.5 billion pesos, according to the General Criteria of Economic Policy 2024 that the Ministry of Finance presented last September.

At CitiBanamex, they estimate that the depreciation of the peso once morest the dollar will increase public debt from 50.5% to 51.2% of GDP in 2024 and from 52.5% to 53.2% in 2025.

Support from Banxico

The Bank of Mexico said this week that it has resources and will use them if necessary if the recent exchange rate volatility in the country worsens due to concerns that a deep judicial reform might scare away investments.

“(Banxico) will be very attentive to the development of our markets and to the possibility that they show atypical behavior or extreme volatility, and in the event of any eventuality that warrants it, it might take the necessary measures, of course, to reestablish an orderly behavior of the same,” said Banxico Governor Victoria Rodríguez.

At a press conference held last Wednesday to present the entity’s biannual financial stability report, the governor of the central bank also explained that any eventual action by the central bank might occur “in operations on its own account or in coordination with other authorities such as the Exchange Commission.”

Comprised of the Secretary and two Undersecretaries of the Treasury, the Governor of the Bank of Mexico and two members of the Board of Governors of the entity, the Exchange Commission is the body in charge of exchange rate policy in the country.

“I would like to remind you that we currently have a foreign exchange hedging program that can be settled in national currency for an amount of up to 30 billion dollars, and if necessary, the Exchange Commission might use it,” added Victoria Rodríguez.

“The announcement by the Bank of Mexico may help moderate the volatility of the exchange rate, especially since the market is already on notice that an intervention program may be announced at any time,” said Jesús López, deputy director of analysis at Banco Base.

ScenarioPerspectives

Political scenario worsens economic prospects for Mexico, Citibanamex said.

Analysis

The supermajority in Congress as a result of the elections of June 2 has changed the economic outlook for Mexico, since there will be no legal obstacles that might prevent any constitutional project by the government and Morena, said the Citibanamex group.

Weakening

“We anticipate a further significant weakening of the political checks and balances on the federal government. We now expect further depreciation of the exchange rate and interest rates, as well as lower economic growth for the country,” the financial institution said in a report.

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