Peso Insurance Costs Soar After U.S. Downgrade: Mexico Credit

The cost of insuring against a decline in the Mexican peso is rising at the fastest pace in more than 2 1/2 years on concern the U.S. may fall into recession, eroding demand for the country’s exports.

One-month options giving investors the right to sell the peso yesterday cost 5.48 percentage points more than contracts to buy. The premium surged 2.98 percentage points in the five days through yesterday, the most since the period ended Jan. 20, 2009. The differential for the Brazilian real jumped 2.51 percentage points over the same period.

Growing signs the expansion in the U.S. is in jeopardy fueled a 3.4 percent tumble in the peso over the past month, the biggest slide among Latin American currencies. Weakening demand from the U.S., the destination for 80 percent of Mexico’s exports, prompted Goldman Sachs Group Inc. and Bank of America Corp. last week to cut their forecasts for growth in the Latin American country.

“If the U.S. slows, Mexico will arguably get hit the hardest of any emerging economy,” Kevin Daly, who helps manage about $7 billion in emerging-market debt at Aberdeen Asset Management Plc. in London, said in a telephone interview. “It just reflects market sentiment. Right now, market sentiment is obviously pretty jittery and guys are getting out.”

The slump in the peso is eroding bond investors’ dollar- based returns. The securities lost 4.6 percent this month, compared with a decline of 2.3 percent for local-currency emerging-market debt, according to Bank of America Merrill Lynch indexes. The yield on Mexico’s benchmark peso notes due 2024 rose four basis points, or 0.04 percentage point, yesterday to 6.56 percent.

Growth Forecasts

The peso’s weakening “is mostly driven by the slowdown concerns in the market about the U.S. economy and a possible double-dip recession,” Jorge Perez-Duarte, managing director for emerging-market foreign exchange at TD Securities Inc. in Toronto, said in a telephone interview.

Standard & Poor’s cut the U.S. government’s credit rating to AA+ on Aug. 5, spurring concern the economic slowdown will worsen. Concern the expansion in the world’s biggest economy is slackening deepened last week after reports showed it grew less than forecast in the second quarter.

Goldman Sachs on Aug. 5 reduced its Mexican growth forecast for this year to 4.1 percent from 4.4 percent and its estimate for 2012 to 3.9 percent from 4.5 percent. A day earlier, Bank of America cut its 2012 growth projection to 4 percent from 4.5 percent, while leaving its forecast for this year at 4 percent.

External Backdrop

“The external backdrop facing the Mexican economy is turning less favorable,” Goldman Sachs economist Alberto Ramos wrote in a research note on Aug. 5. U.S. growth in the first half of the year “disappointed,” wrote Ramos, who is based in New York.

The peso rose 2.4 percent yesterday to 12.0391, rebounding from an 11-month low earlier in the day, after the Federal Reserve vowed to keep interest rates near zero through mid-2013. U.S. stocks jumped the most in more than two years, rebounding from the worst drop since 2008, and 10-year Treasury yields touched a record low.

The Mexican currency weakened 0.7 percent to 12.1201 per U.S. dollar at 7:38 a.m. in New York.

The extra yield investors demand to hold Mexican government dollar bonds instead of U.S. Treasuries fell nine basis points to 166 today, according to JPMorgan Chase & Co.

The cost to protect Mexican debt against non-payment for five years increased three basis points yesterday to 156, according to CMA. Credit-default swaps pay the buyer face value in exchange for the underlying securities or cash equivalent if the issuer fails to comply with debt agreements.

Futures Contracts

Yields on futures contracts for the 28-day TIIE interbank rate due in September fell 11 basis points yesterday to 5 percent, indicating traders expect the central bank will wait until that month to raise benchmark borrowing costs from a record low 4.5 percent.

Benito Berber, a strategist at Nomura Securities Inc. in New York, said he’s keeping his year-end forecast for the peso to strengthen to 11.5 percent as swings in global markets ease.

“The Mexican peso will come back,” Berber said in a telephone interview. “With any sort of normalization, the Mexican peso is going to rally a lot. This is so volatile that it’s very difficult to change your forecast right now.”

The peso tumbled 20 percent in 2008 as U.S. demand for the country’s exports slumped. Mexico’s economy, Latin America’s second-biggest behind Brazil, shrank 6.1 percent the following year, the most since 1995. The U.S. economy contracted 3.5 percent in 2009.

“We all know the high correlation to the U.S.,” Aberdeen’s Daly said. “It does take the brunt of the pressure from a downturn in the U.S.”

To contact the reporters on this story: Benjamin Bain in New York at bbain2@bloomberg.net; Bryan Gibel in New York at bgibel@bloomberg.net

To contact the editor responsible for this story: David Papadopoulos at papadopoulos@bloomberg.net

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