Mexico: Weathering the Tariff Tempest

Mid Week Bond Update

Mexico: Weathering the Tariff Tempest

Mexico's economy has been resilient in the face of recent pressures.


While U.S. talks with China have dominated headlines about trade, it’s easy to overlook the lack of resolution of a new trade agreement between the U.S., Mexico and Canada to replace NAFTA.

While that’s less than ideal for Mexico, recent data suggest that the country’s economy is improving – in part because of pressures brought to bear by its northern neighbor.

Indeed, Mexico is now generating a current account surplus of over 1% of GDP for the first time since 1988 – a sign that the country’s economy is currently much less dependent than in previous decades on foreign investment inflows to fund its day-to-day activities.
 

Mexico Current Account Percent  of GDP, 1979-2019

Chart courtesy of Brandywine Global. Source: Haver Analytics, Brandywine Global. Past performance is no guarantee of future results. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

Brandywine Global points out that part of the current account surplus is due the balance of payments surplus for travel, now over 1.3% of GDP. That’s because foreign tourism to Mexico has picked up strongly at the same time as more Mexican citizens are choosing to staying home rather than seek work abroad.

The upshot of these trends is a balance of payments surplus of a size not seen since the mid-2000s, when the Mexican peso was nearly 30% stronger than current levels on an inflation-adjusted basis. That balance of payments surplus indicates that the country's economy is healthy enough to thrive without the prospect of the bailouts that have plagued emerging (and a few developed) economies over the years -- and could merit attention from investors, especially if Mexico’s fundamentals continue to improve.
 

On the rise: Brexit pre-deadline optimism

Warranted or not, financial markets appear to have taken the upbeat tone of the news flow at face value. The spread between 10-year Gilts and Bunds, having spiked at 117.9 basis points on October 11, 2019, fell to 110.3 bps at close of trading on October 15; the yield on two-year Gilts fell some 5 bps, from 0.57% to 0.52%. The British pound, buffeted by the news flow in recent weeks, rose against the dollar to $1.278 and to €1.158 against the euro as of 3:00 PM on October 15.

The rapid pace of negotiations between the UK and the rest of the European Union make prognostication all but impossible at this stage, making the resolute optimism of markets all the more striking. But the generally positive tone of the official statements coming from London, Dublin and Brussels is no less surprising, and potentially no more long-lasting.
 

On the slide: Consumer expectations for inflation three years out

The New York Fed’s September 2019 edition of its monthly Survey of Consumer Expectations showed a decline for inflation three years ahead, to 2.4%, the lowest reading for three years out since the data series began in June 2013. For one year ahead, median inflation expectations rose slightly, to 2.5%. At the same time, median inflation uncertainty one year ahead showed a slight increase at the one-year mark.

Inflation expectations matter to the FOMC in making its decisions about benchmark rates; expectations are considered by many to be self-fulfilling, affecting future consumer spending and saving. That interest on the part of the Fed was reflected in the minutes of its September 18th meeting, which stressed that : “…these values pointed to the possibility that inflation expectations were below levels consistent with the 2% objective or could soon fall below such levels.”

If consumer expectations continue their downward trend, talk of the Fed becoming newly aggressive about cutting rates to stimulate the economy could end up being self-fulfilling as well.

 

Note: All dates are 2019 unless otherwise indicated


Please note: All prices and other data are as of  October 15, 2019, 5:00 PM ET, unless otherwise indicated.

Definitions:

"Brexit" is a shorthand term referring to the UK vote to exit the European Union.

A current account balance summarizes the flow of goods, services, income and transfer payments into and out of a country

A current account deficit is when a country's government, businesses and individuals import more goods, services and capital than they export.

A current account surplus is when a country's government, businesses and individuals export more goods, services and capital than they import.

Gross Domestic Product (“GDP”) is an economic statistic which measures the market value of all final goods and services produced within a country in a given period of time.

USMCA, NAFTA: The Agreement between the United States of America, the United Mexican States, and Canada is a signed but not ratified free trade agreement between Canada, Mexico, and the United States. It is referred to differently by each signatory—in the United States, it is called the United States–Mexico–Canada Agreement (USMCA); in Canada, it is officially known as the Canada–United States–Mexico Agreement (CUSMA) in English and the Accord Canada–États-Unis–Mexique (ACEUM) in French; and in Mexico, it is called the Tratado entre México, Estados Unidos y Canadá (T-MEC). The agreement is sometimes referred to as "New NAFTA" in reference to the previous trilateral agreement it is meant to supersede, the North American Free Trade Agreement (NAFTA).

basis point (bps) is one one-hundredth of one percentage point (1/100% or 0.01%).

“Gilts” are bonds that are issued by the British government.

Bunds” refers to bonds issued by Germany's federal government.

The U.S. Federal Reserve, or “Fed,” is responsible for the formulation of a policy designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments.

The Federal Open Market Committee (FOMC) is a policy-making body of the Federal Reserve System responsible for the formulation of a policy designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments.

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