Mexico: Peso is still likely to weaken – BBH

According to analysts from Brown Brother Harriman, Mexican assets are likely to remain under pressure from heightened political risks and also with the context of a broad-based EM negative tone.

Key Quotes:

“Mexico just announced retaliatory tariffs on US pork, steel, and whisky. This was in response to US tariffs on Mexican steel and aluminum on national security grounds.”

“Recent reports also suggest the US wants separate NAFTA talks with Canada and Mexico.   We do not believe either country will play into this US strategy of “divide and conquer.” Under these deteriorating conditions, our base case is that there is no NAFTA deal this year.”

“What’s worse, tensions are likely to worsen if AMLO wins, as his approach to President Trump is likely to be more confrontational.”

“We continue to believe that if AMLO wins, he will be more like Lula than Chavez. Whilst some of his rhetoric concerning the petroleum sector have raised eyebrows, AMLO has often walked back these comments.”

“The economy remains sluggish. GDP growth is forecast by the IMF at 2.3% in 2018 and 3.0% in 2019 vs. 2.0% in 2017. GDP rose only 1.3% y/y in Q1, down from 1.5% peak in Q4 and the weakest since Q4 2013. As such, we see downside risks to the growth forecasts. Trade tensions are also likely to be a headwind on the economy.”

“Price pressures are falling. CPI rose 4.55% y/y in April, the lowest since December 2016 but still above the 2-4% target range.”

“Next policy meeting will be held June 21, and much will depend on how the peso is trading then. If this current bout of weakness persists, then we think another rate hike ahead of the election is likely.”

“USD/MXN has broken above the key level of 20.2860. Break above that 62% retracement objective sets up a test of the January 2017 high near 22.0385.   We expect the central bank to issue more FX swaps in the coming weeks to help support the peso. However, within a context of a broad-based EM bear market, the peso is still likely to weaken.”

“With the weak peso likely to feed into higher inflation and the central bank possibly hiking rates again, we think Mexican bonds will underperform near-term.”