To say that the Mexican peso has been the punching bag of choice for investors would be an understatement.
The currency has shed nearly a fifth of its value since the start of 2016 as disappointing growth, followed by jitters over the direction of US interest rates, gave way to panic over the rise of Donald Trump and the knock-on effect his protectionist “America First” plans would have on Mexico’s export-driven economy.
But having fallen through the MXN 22 per dollar mark to a new all-time low earlier this month after Mr Trump warned of a possible “major border tax” against companies that move jobs to Mexico, could the currency now be a buying opportunity?
Not quite, says UBS.
“Is this a great buying opportunity? That will depend on what degree of trade protectionism is priced in, and whether future risk-reward is favourable,” said Bhanu Baweja, a currency strategist at the bank.
Mr Baweja said that while his team’s calculations reckon the peso is already pricing in a roughly 70 per cent chance that the US would impose a 20 per cent tariff on Mexican exports, the downside risks to the currency remains high.
Among the reasons to be cautious? The uncertain outlook for FDI flows as well as the risk that remittances from the US to Mexico could get taxed.
Mr Baweja also argued that the Mexican peso is unlikely to stage the kind of rip-roaring recovery the Brazilian real saw in 2016 following a torrid 2015. As he explained:
1. The starting points of valuations are very different – at its low Brazil’s market fell to only 8.9x of forward earnings, a discount of 15% to EM’s earnings then. By contrast, Mexico’s Bolsa is still at a price multiple of 16.6x to its earnings, a premium of 41% to EM’s valuations today.
2. To assess whether Mexico can indeed ‘do a Brazil’ we must focus on the differences in their balance of payments. Brazil’s current account adjustment was sharp…[with the deficit dropping] a good 4% of GDP between end 2014 and mid-2016…While Mexico’s fiscal dynamics have deteriorated in recent years, both the nominal deficit and the debt-to-GDP ratio remain at more manageable levels. This reduces the risk that Mexico’s growth will suffer from a large correction in domestic absorption, but it also means that the improvement in the country’s current account deficit will be a more muted over the next two years.
3. The on ongoing decline in oil production – which by the government’s own admission could fall by close to 10% this year – prevents an even larger improvement in Mexico’s trade balance, even in the face of rising oil prices.
4. Mexico’s current account remains weighed down by a large deficit in its income balance, a reflection of increased borrowing from foreigners in recent years.
5. The reform momentum in Brazil turned sharply positive; policy became intent on anchoring fiscal expenditure and reining in public debt growth. Mexico has already followed very orthodox policy (arguably more so in the monetary than in the fiscal realm) but the risks are now rising that reform momentum actually slows.
So what could be the catalyst for UBS to buy the peso?
At the very least, we would wait for a) some clarity on the level and scope of any tariffs, b) for the trade balance build on its recent move into positive territory, and c) some signals on companies’ intention to continue their FDI into Mexico
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