RBC Capital’s Peso Trade Collapses as Volatility Surges: Mexico Credit

Mexican peso bulls including RBC Capital and Nomura Securities Inc. are abandoning their trade recommendations as concern the U.S. may relapse into recession mounts and currency swings soar to a two-year high.

RBC “stopped out” its call for clients to buy the peso versus the dollar according to a research note on Aug. 18, one day after it recommended the trade. Investors who followed the advice lost 1.5 percent. Nomura exited a recommendation investors buy the peso versus Colombia’s currency, according to a research note on Aug. 8, after the trade netted a loss of 2 percent in six days. The bank said it’s likely to lower its year-end forecast for the Mexican peso.

The peso is the worst performer among the 16 major currencies tracked by Bloomberg, having tumbled 5.2 percent in the month through Aug. 19 on concern slowing U.S. growth will crimp demand for the Latin American country’s exports. While yields on Mexican bonds are tumbling in line with U.S. Treasuries, the peso’s slump is eroding dollar-based returns on the securities.

“We’re back to extreme financial market turbulence,” Paul Biszko, an emerging-markets strategist at RBC, said in a telephone interview in Toronto. “I thought there was going to be a period of external stability. To try to call when that’s going to end is very difficult.”

The peso’s drop handed investors in Mexican local bonds a loss of 0.09 percent this month in dollar terms even as yields on benchmark bonds due in 2024 tumbled 75 basis points to a record low of 6.04 percent, according to data compiled by Bank of America Merrill Lynch. Brazilian bonds denominated in reais gained 1.6 percent in dollar terms during the same period.

‘Dangerously Close’

The average currency fluctuation over the past two weeks reached 29.4 percent on Aug. 18, the highest level since April 2009, according to data compiled by Bloomberg.

The peso has erased almost all this year’s gain and reached an 11-month low of 12.7686 on Aug. 9 as slowing global growth sparked a sell-off in world equity markets. The U.S., the destination for 80 percent of Mexico’s exports, and Europe are “dangerously close to recession,” Morgan Stanley economists said last week. Mexico’s central bank lowered its 2011 growth forecast on Aug. 10. Policy makers are now forecasting an expansion of up to 4.8 percent from a previous estimate of as much as 5 percent.

The market rout “caught everybody by surprise,” Benito Berber, a strategist at Nomura in New York, said in a telephone interview. “A 10-15 percent drop in equity markets in a couple of days is beyond any analyst’s ability to predict. When I put on the trade recommendation, I didn’t expect the market to depreciate that much. We thought the peso could rally a bit or at least be stable.”

‘Favorable’

While Berber has a “favorable” view on the peso, he said he plans to pare back his forecast that the currency will strengthen to 11.5 per dollar by year-end.

The median forecast of analysts surveyed by Bloomberg is for the peso to rebound to 11.7 per dollar by the end of December, down from 11.62 on Aug. 10. BMO Capital Markets, the investment arm of Canada’s fourth-largest lender, has the most bearish forecast, estimating the peso will weaken to 12.6 per dollar, compared with a prediction of 11.6 in July.

Morgan Stanley and BNP Paribas SA are among the bulls still advising their clients to bet on a peso rally. Rogerio Oliveira, an emerging-markets strategist at Morgan Stanley, recommended on Aug. 17 that investors buy the peso against the dollar through options, betting on a 1.1 percent gain.

“The world has been downgraded in terms of growth expectations, but the world is not falling apart,” Oliveira said in a telephone interview in New York. “The peso has taken a disproportional amount of the global shock compared with the other currencies. The peso is bound to catch up.”

Rate Futures

Diego Donadio, a strategist at BNP, on Aug. 9 advised clients to buy the peso versus the Brazilian real, predicting a rise to 7.35 pesos per real from 7.67. The trade has since lost about 0.2 percent.

The peso rose 0.6 percent to 12.2272 per dollar at 8:05 a.m. New York time.

The extra yield investors demand to hold Mexican government dollar bonds instead of U.S. Treasuries fell four basis points to 179, according to JPMorgan’s Global EMBI+ index for the country.

The yield on futures contracts for September, known as TIIE, fell 12 basis points last week to 4.71 percent, indicating traders expect the central bank to lower the rate next month from a record low 4.5 percent.

‘Overshot’

The cost to protect Mexican debt against non-payment for five years fell six basis points last week to 144, according to data provider CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market. Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent if a government or company fails to adhere to its debt agreements.

RBC, the investment unit of Canada’s largest bank, recommended clients buy the peso on Aug. 17, when it traded at 12.17 per dollar, according to the bank’s research note. Analysts including Biszko said the 5 percent selloff this month had “overshot” and the peso will “outperform” over coming weeks when global financial markets stabilize.

The following day, the peso lost as much as 2.2 percent after a report showed manufacturing in the Philadelphia region contracted in August by the most in two years. The peso weakened beyond the 12.35 level RBC set as a “stop-loss,” or a pre-set buying order to limit losses.

“We thought the worst may have gone behind us,” Biszko said. “We thought the Mexican peso has been beaten up already, but the viciousness of the swings happens so frequently that it’s extremely unpredictable.”

Bullish Bets

RBC maintains its forecast that the peso will rise to 11.5 per dollar by year-end as global markets “stabilize,” Biszko said. That would represent a 6.9 percent rise from the close on Aug. 19.

Hedge funds and other investors have cut their bullish bets on the Mexican peso to the lowest level since September 2010, according to data compiled by the Commodity Futures Trading Commission. Wagers on the peso strengthening against the dollar outnumbered bets on a decline in the futures market by 22,634 contracts as of Aug. 16, compared with 41,293 the prior week, according to the CFTC. The bets have declined 83 percent since a record set in April.

Kieran Curtis, who helps manage $3.5 billion at Aviva Investors in London, said he’s not ready to buy the peso after unwinding his bearish trade when the currency reached 12.5 per dollar this month.

“We are a bit more cautious on the general risk environment,” Curtis said in a telephone interview. “If you have a risk-off environment, it tends to fall more than others.”

To contact the reporters on this story: Ye Xie in New York at yxie6@bloomberg.net;

Veronica Navarro Espinosa in New York at vespinosa@bloomberg.net

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

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