domingo, 22 de febrero de 2015

When can a central bank stand against the markets?

What central bank can hope to fight off successfully a run against its currency? Maybe the Chinese central bank: the country's US$3.8 trillion in reserves gives it a fighting chance at beating off an attack. To put the number in perspective, that's more than three times Mexico's GDP. It's also a sixth of total world reserves.

While Chinese exporters would be happy with a weaker renminbi, Chinese companies and banks have borrowed an estimated US$1 trillion over the last five years, mostly dollar-denominated, short-term loans. They certainly aren't happy with a depreciating renminbi.

Mexico has run sizable capital account surpluses in recent years, which the peso's movements have reflected. In 2013, US$64 billion of capital flowed (net) into Mexico; in the first nine months of 2014, net capital inflows were US$40 billion. Capital flows are a different order of magnitude in China. In the fourth quarter of 2014, capital outflows from China were US$96 billion!

The same is true of the two countries' tourism position. Last year, Mexico posted a record US$6.6 billion surplus in the tourism account. In the fourth quarter of 2014, China ran a US$36.4 billion deficit in its tourism account.

jueves, 19 de febrero de 2015

Not only did Banco de Mexico reduce its growth forecast...

Yesterday, Mexico's central bank cut its projection for this year by half a percentage point, to 2.5% - 3.5%.

More telling was the concluding paragraph of the summary of the bank's quarterly analysis, which baldly stated that macroeconomic stability isn't enough to improve societal well-being. "Adequate implementation of structural reforms is indispensable" if Mexico is to be more competitive and productive and the domestic economy, a more important motor of growth.

The eye-opener was the Bank's ringing endorsement of the rule of law: "It is of the greatest importance to work on the institutional transformation of the country, in order to build a more solid rule of law and create greater judicial certainty for society." 

lunes, 2 de febrero de 2015

What's middle class?

Income isn't the only way to define "middle class". Education is another. Aspirations are as well. Last week's blog took a look at the evolution of the US middle class -- defined as a household earning between US$35,000 and US$100,000 a year.

I thought it would be interesting to see to which income decile a Mexican household with that income would fall. Here are the numbers for 2012, the most recent year available from INEGI.

Households earning US$32,037 a year were in the top 70% of the income distribution in Mexico. Household income of US$40,857 were in the top 80% while US$56,329 were in the top 90%. Household income for the top 10% averaged US$123,587.

martes, 27 de enero de 2015

The American middle class...

A fascinating look (in graphs) at the composition of the middle class in the US between 1967 and 2013... Until 2000, the middle class declined because people were moving into the upper class. Since 2000, movement into the lower class drove the shrinkage of the middle class. See:

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


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

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.