Investors warm to Mexico, lifting peso, despite battered economy

Mexico in 2020 plunged into its steepest recession in decades and suffered a credit ratings downgrade, yet the peso currency and instruments that measure sovereign risk now tell a different story: that investors are again warming to the country.

The peso, one of the main indicators of risk appetite, earlier this month hit a nine-month high of 19.68 per dollar.

That compares with a record low of nearly 26 pesos per dollar in April as the coronavirus pandemic walloped the global economy and the cross-border value chains on which Mexico relies.

And though the peso on Friday was still down 6% from the start of the year, it is the biggest gainer in the last eight months out of 25 emerging-market currencies tracked by Reuters.

Strong monetary policy fundamentals and the government’s fiscal discipline have also lowered risks, investors and market strategists said. Still, the Bank of Mexico, the country’s central bank, sees the economy contracting 8.9% this year.

“The market right now is especially rewarding those (countries) that kept … prudence in fiscal policy matters,” Raul Martinez-Ostos, general director of bank Barclays in Mexico, said at a conference earlier this week.

However, there is room for relations between the private sector and the government to improve, which would help fuel more investment, Martinez-Ostos added.

President Andres Manuel Lopez Obrador has spent much of his term at odds with corporate bosses, arguing that past administrations were captive to powerful business interests and mired in graft.

In line with optimism over the peso, Mexico’s five-year Credit Default Swaps (CDS), which cover the risk of sovereign default, fell to 83 basis points (bp) in December – almost the same level as before the pandemic.

That is a stark change from the end of April, when Mexico’s CDS reached 309 bp.

By contrast, other emerging economies often compared to Mexico, including Brazil, Turkey and South Africa, now have five-year CDS levels of 152, 355 and 203 basis points, respectively.

Meanwhile, the spread, or risk premium to U.S. 10-year Treasury bonds on Mexico’s equivalent debt, stands at 453 bp; Brazil’s is 647 bp, Turkey’s 1,199 bp and South Africa’s 794 bp.

Ratings agency S&P recently forecast Mexico’s fiscal deficit will be lower than that of other emerging markets in 2021, but warned that the weak finances of state oil firm Pemex could still lead to a sovereign downgrade within 12 to 18 months.

Analysts expect investors to stay positive on Mexico going into 2021 now that external risks such as the U.S. presidential election and uncertainty over COVID-19 vaccines have dissipated.

But there are no guarantees.

A controversial draft law that will oblige the central bank to buy up cash that commercial banks cannot return to the financial system caused peso volatility this week, helping to push the currency back over 20 per dollar.

The CDS did not react to the proposed legislation.