martes, 9 de diciembre de 2014

What's going on with the peso?


The fix rate surpassed $14 on December 2 for the first time in thirty months. On Monday, December 8, the cost of a dollar had jumped to $14.40. That same day, the Exchange Commission announced it is reviving the auction mechanism it devised in October 2008 as a “preventative measure”. If the exchange rate moves more than 1.5% in the course of a single trading day, Banco de México (Banxico) will sell up to US$200 million dollars into the exchange markets. Today, the 9th, the fix rate retreated three centavos, the first drop in the cost of a dollar since mid-November.

A couple of hundred million dollars isn’t enough money to stop a run on the peso. In the past, though, it’s proven to be enough to prevent a panic from spreading. When trading volumes are low, a few transactions can send the exchange rate soaring. The idea behind the auctioning of options to buy dollars is simple: since a large, abrupt jump in the cost of a dollar can cause investors to sell pesos first and ask questions later, make some more dollars available to give investors time to see if the problem is more than one of thin markets.

The fundamental question is why the peso has been steadily weakening since May. The strength of the dollar is an explanation that highlights the fact that developments outside of Mexico are behind the weakening of the peso and that the peso isn’t alone: the currencies of other emerging markets have weakened along with the Euro. That’s not the only story, though.

Portfolio investment flows are another face of the same coin. Those depend on the attractiveness of peso-denominated investments compared to investments in other currencies and the fluctuations in investors’ appetite for risk and search for returns.  The magnitude of portfolio investment flows can swing wildly from quarter to quarter. This year provides a good example. In the first nine months of 2014, portfolio investment totaled US$19.9 billion. Of that, US$4.9 billion entered in Q1 and US$13.4 billion, in Q2. Inflows in Q3 plunged to US$1.7 billion, their lowest level since the financial crisis with the exception of the “taper tantrum” in Q2 2013 sparked by the announcement that, at some point, the Fed would begin to dial down asset purchases.

Will the peso strengthen or will it continue to depreciate? In 2011 and 2012 – not so very long ago – we saw steeper jumps in the cost of a dollar, ones followed by a recovery of the peso. In July 2011, the cost of a dollar averaged $11.67. Five months later, a dollar cost, on average, $13.76. Two months after that, in February 2012, the cost of a dollar averaged $12.78, only to bounce back to $13.92 in September. Over the course of fourteen months, the fix exchange rate traded in a $2.25 range (monthly averages), ending the period $1.27 higher than it began. By those standards, the peso’s variations over the last fourteen months have been relatively mild. In October 2013, the fix rate averaged $13.26. Assuming, for a moment, that the rates we’ve seen in the first six trading days of December hold for the rest of the month, the range will be less than a peso.

Don’t expect the peso to appreciate much before Christmas: between holiday travel plans and normal quarter and year-end business transactions, there’s typically a seasonal increase in the demand for dollars. We don’t expect investors to redeploy money to emerging markets towards the end of the year, as they often do once they’ve locked in their annual bonuses.

The peso could well appreciate at the very end of the year. Then again, it might not. Relative returns, confidence, oil prices, and perceptions of the strength of the world economy will all play a role in determining capital flows. But, foreign investment flows don’t depend on just exogenous events. The reforms approved during this Administration piqued interest in Mexico’s future. While investors in money market obligations may focus most on how returns today compare to returns in other countries, equity investors will be very interested in how the reforms passed during this Administration are implemented.

viernes, 17 de octubre de 2014

Oil...


When Hacienda sent the Administration’s budget proposal to Congress on September 5, US$82 for a barrel of Mexican export crude seemed extremely conservative. Five weeks later, it doesn’t look quite so unlikely: on October 16, Mexican export crude sold for US$76.70. The “puts” Hacienda purchases each year to protect the budget from a sharp drop in oil prices may be in the money in 2015. (With an exercise price of US$80, the puts are well worth their US$450 million estimated cost.) 

Lower oil prices mean larger trade and current account deficits. A larger current account deficit requires larger capital inflows to finance it – at a time when capital flows to emerging markets are declining. Bad luck for Mexico...

lunes, 29 de septiembre de 2014

Ouch: the peso returns to beginning of year highs...

The fix rate peso jumped to $13.49 today, matching its January 24 high for the year. The  monthly fix rate averaged $13.23 with just a day left in September, in line with its first quarter average. Just two months ago, in July, the fix rate averaged $12.98. What's going on?

The explanation undoubtedly lies in portfolio investment flows and the impact of a stronger dollar on the attractiveness of carry trade investments. The carry trade entails borrowing in a strong currency (like the dollar) and investing the proceeds of the loan in bonds in a weaker currency (like the peso) that pay a higher interest rate than that charged on the dollar loan. So long as the dollar doesn't strengthen (or, the flip side, the peso doesn't weaken), investors reap the yield differential. If the dollar weakens (or the peso strengthens), the currency losses can swamp the gains from the interest rate differential.

The size of the carry trade in emerging markets isn't really known. However, one estimate puts it at a very hefty US$2 trillion. The Bank for International Settlements indicates that foreign ownership of emerging markets' debt rose from 8% in 2007 to 17% in 2012.

Mexico was an early beneficiary of carry trade inflows. The relative size and depth of its bond markets mean that peso-denominated bonds remain an important destination for foreign investors. In Mexico, along with Poland, Hungary and Indonesia, foreign investors hold 35% or more of government bonds.

The strength of the dollar translates into weaker currencies around the world, including the peso. Today's Financial Times presents three reasons why the dollar will remain strong: the recovery of the US economy, the end of QE, and the ECB's adherence to a more dovish monetary policy. (See the complete article at http://www.ft.com/intl/cms/s/0/27a516d8-47e4-11e4-be7b-00144feab7de.html#axzz3EjWzUWOC)

Unless peso interest rates rise or the peso strengthens, portfolio investment is not likely to flow into Mexico in the massive quantities we saw in 2011 and 2012.

lunes, 15 de septiembre de 2014

Mexico exports terrorists?

There are people in the US who believe that ISIS (or ISIL, aka Islamic State) terrorists are about to or have infiltrated the US from Mexico, amongst them Texas Governor Rick Perry. The Department of Homeland Security isn't amongst them.

For the story, see http://www.nytimes.com/2014/09/16/us/us-pushes-back-against-warnings-that-isis-plans-to-enter-from-mexico.html?emc=edit_tnt_20140915&nlid=20064986&tntemail0=y&_r=0

miércoles, 3 de septiembre de 2014

All in favor of borrowing abroad...


Mexico’s net foreign debt rose US$22.3 billion in the first half of 2014. The 56.3% increase over the same period of 2013 was thanks to the enormous jump in net indebtedness that occurred in the second quarter. In the second quarter of this year, Mexico borrowed abroad (net) US$20.5 billion, a sharp contrast to the (net) repayment of US$4.5 billion in the second quarter of 2013.

Public sector borrowing drove the jump in foreign debt. The net public sector foreign debt crept up US$0.1 billion in the first half of 2013. In the first half of 2014, it soared US$12.6 billion. Borrowing by the non-banking public sector drove the jump. Development banks’ net borrowing was imperceptible. Public sector companies took on US$12.5 billion in the first six months of 2014; in the first six months of 2013, their net borrowing inched up US$0.7 billion.

The private sector continued to borrow abroad in the first six months of this year but at a slower pace: the US$9.8 billion net increase was 31.0% less than in the first half of 2013. Companies and banks’ net foreign debt in the first half of 2014 rose, respectively, by US$5.6 billion (30.0% more than in the first six months of 2013) and US$4.2 billion (57.6% less). 

martes, 2 de septiembre de 2014

Some foreign investors returned to Mexico in the second quarter...


Foreign direct investment (FDI) in the first half of this year totaled US$9.7 billion, slightly more than half the amount of portfolio investment and just a third of its level in the first six months of 2013. Europe supplanted the US as the principal sources of FDI in the first half of this year, with 26.1% of the total coming from Spain, 20.1% from the Netherlands, and 13.0% from Belgium. Only a tenth came from the US while Japan, Canada, and Germany were the sources, respectively, of 7.2%, 4.9% and 3.9% of the total. Most of FDI (71.8%) in the first six months of 2014 went into manufacturing. Financial services attracted a fifth of the total and the remaining 7.9%, into all other sectors. 

FDI totaled US$20.2 billion in the second quarter of last year; in this year's second quarter, FDI was just US$2.3 billion. Obviously the AB INBev/Modelo transaction swelled last year’s number. However, a very unusual occurrence also affected FDI in this year’s second quarter: new investments were negative. Reinvested profits totaled US$4.0 billion in Q2 2014 while net liabilities with parent companies rose US$1.4 billion, offsetting the US$3.2 billion reduction in new investments. (There is an outflow of the same amount registered in the current account for reinvested profits. Neither new investments nor changes in inter-company liabilities have a current account counterpart.)

Portfolio investment in the first half of this year was US$18.2 billion, nearly three times its level in the first half of 2013 when the “taper tantrum” hit portfolio investment in emerging markets in the second quarter. The big change was in foreign investment in equities, which constituted a whopping 35.9% of portfolio investment in the first half of the year. The US$6.6 billion of foreign investment in equities really occurred in the second quarter; only US$0.3 billion flowed in during the first. It’s a sea change from the first half of last year, when foreigners cut their investments in Mexican equities by US$4.9 billion. Foreign investment in money market instruments was US$11.7 billion, 5.5% above its level in the first half of 2013. 

jueves, 14 de agosto de 2014

Whew! An inflow into high yield bond funds

Reports say investors put US$0.68 billion into high yield bond funds in the week ending August 13. That's a welcome relief after the US$7.1 billion outflow of the prior week.

Meanwhile, though, other worrying trends in the financial markets have Fed officials and bankers on edge. Liquidity is not as abundant in the "repo" market as it was. "Repos" are repurchase agreements in which borrowers sell government bonds (principally) for cash to a third party at the same time they promise to repurchase the bonds at a slightly higher rate in the future.

That some banks are reported to be reducing their role as middlemen in the repo market is important because financial institutions like banks and hedge funds use repos for funding. Repo markets froze up in the 2008 crisis, threatening the international financial system.

No one is suggesting that repo markets are on the verge of a 2008-style seizure. However, two Fed regional presidents  expressed their concern about repo markets this week.