perspectives d’investissement
Nationalism and NAFTA: Mexico prepares to elect a president
Lombard Odier Private Bank
The rhetoric between the US and Mexico over tariffs and the future of the North American Free Trade Agreement (NAFTA) may be about to worsen. Investors are questioning whether an almost-certain “centre-left” presidential victory in Mexico next month will further complicate trade with its northern neighbor and most important market.
We believe that while the risks to investment in Mexico are binary and centre on NAFTA and the 1 July election, Mexico’s fundamentals are still positive. Its working-age population is expanding as a share of the wider demographic and it has an increasingly competitive labour force, even in comparison with economies such as China. This means that growth has remained relatively resilient over the past two years, despite headwinds.
When Mexico’s voters go to the ballot box, there are good reasons for investors to pay attention. At 5%, the country’s sovereign debt represents the largest weighting in JP Morgan’s Emerging Markets Bond Index Global Diversified in USD. And with debt around USD 109 bn, it accounts for more than 12% of JP Morgan’s unconstrained emerging market index. Mexico’s political uncertainties are also part of a wider Latin American anti-establishment risk pattern that includes Brazilian unrest and next year’s Argentine elections.
Barring surprises, Andres Manuel Lopez Obrador, known as AMLO, and who has a near two-to-one lead over his nearest rival, will be elected president on his third attempt. This time he’s being helped by defining himself as “centre-left” and in opposition to the US administration. Comments by President Donald Trump about immigrants and border walls play into AMLO’s hands, and seem likely to finally bring him the presidency.
An opinion poll published by Mexican newspaper El Financiero on 4 June put AMLO’s share of the vote at 50%, widening his lead to 26 percentage points ahead of his nearest rival. The ruling PRI (Partido Revolucionario Institucional) is running third, after being in power from 1929 to 2000. Since 2012, PRI’s Enrique Peña Nieto has proven the least popular president in 25 years.
AMLO has also been careful to meet and reassure foreign investors, including BlackRock Inc. Chief Executive Officer Larry Fink. AMLO’s proposed finance minister, Carlos Urzua, has been talking up a growth target of 5% by the end of a six-year term (compared with 2.3% in 2017) and a commitment to running a budget surplus of 0.5 to 1%.
Corruption and oil
AMLO’s electoral promises have centred on Mexico’s corruption, starting with its political parties and including measures such as a crack-down on waste and conflicts of interest, procurement practices and tax havens. In rankings published by the World Economic Forum, Mexico is rated one of the worst countries in terms of public trust in politicians (127th out of 137) and organised crime (134th/137).
Other policy pledges, which have been described as nationalistic, include social measures such as doubling pensions and free higher education, which, AMLO’s campaign says, would be paid for by the corruption clamp-down.
Most importantly for foreign investors, AMLO plans to import fewer refined petroleum products while supporting the domestic oil industry. He also talks of freezing oilfield contracts to tackle suspected corruption cases.
Pesos and piñata
Fears over the uncertainty that AMLO will bring to the presidency, and a ‘Mexico-first’ style approach to the economy, have prolonged the peso’s weakening to 20.34 pesos per USD on 11 June, its lowest level since February 2017. The currency has fallen in line with President Trump’s threats to sideline or scrap NAFTA in favour of individual trade agreements with Canada and Mexico. That same month, the Banco de México, which supports a free-floating peso, implemented a USD 20 bn hedge as the falling currency threatened higher inflation.
The yield on Mexican government 10-year bonds has risen steadily since early April, to 7.85% on 8 June, and the spread between Mexican sovereign bonds and the US Treasuries has widened to 489 basis points (bps) from around 443 bps over the same period. In response to the weakening peso, the Banco de México moved as early as 2016 into a tightening cycle to counter investors’ move back into dollar-denominated debt.
Tariff tensions
It’s hard to overstate the importance of Mexico’s relationship with the US; Americans buy 80 percent of Mexican exports by value, equivalent to one-third of the nation’s gross domestic product.
The recent US tariffs have prompted unusually robust and coordinated responses from both the US’s NAFTA partners as well as the European Union at a tense G7 meeting. Mexico has retaliated ahead of November mid-term elections in the US, targeting vulnerable Republican seats with import tariffs on pork, apples, potatoes, cheese and bourbon plus a number of steel products.
Even if President Trump doesn’t deliberately scrap NAFTA, the 1994 accord may be undermined as Mexico and Canada look to challenge US trade tariffs through the World Trade Organisation’s dispute mechanism, a process that will take years and be complicated by their own retaliations.
It’s easy to focus on AMLO and get caught up in personality politics. But we should remember that polling suggests AMLO’s party may win the lower house of Congress, but is unlikely to gain a majority in the Senate, leaving him forced to make concessions in order to push legislation forward. In particular this may kill off AMLO’s plans to undo energy reforms.
Key takeaways
- Mexico’s fundamentals remain supportive.
- Barring surprises, “centre-left” Andres Manuel Lopez Obrador will be elected Mexico’s president.
- Mexico is the largest weighting in JP Morgan’s USD-denominated EMBI Global Diversified index.
- AMLO’s presidential campaign promises may be tempered if his party fails to win an overall majority in parliament.
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