Mexico’s benchmark peso bonds are on a record-long losing streak as concern mounts that the central bank is waiting too long to raise interest rates.
Yields on the government’s 10 percent bonds due 2024 rose to an 11-month high of 7.99 percent in March as prices fell in each month since November, the biggest stretch of declines since the notes were sold in 2005. The bonds lost 5.4 percent this year, compared with a decline of 1.1 percent on similar-maturity Brazilian debt and a 0.1 percent gain on U.S. Treasuries.
Mexico is the only major Latin American country that hasn’t boosted borrowing costs in the past year as consumer prices rise at the third-slowest pace in the region after Chile and Peru. Some investors speculate that central bank Governor Agustin Carstens will struggle to keep inflation near the bank’s 3 percent target as the U.S. recovery helps Mexico to its fastest economic expansion since 2000.
“It’s hard to believe that people think that Mexico is so dynamic that it will be able to reach 3 percent inflation when the world is facing a wave of inflation,” Javier Orvananos, the manager of the country’s biggest pension fund at Citigroup Inc.’s Banamex unit, said in a telephone interview from Mexico City. Further increases in U.S. yields will keep driving up those in Mexico “toward the end of the year,” he said.
Pension funds, the biggest buyers of Mexican government peso debt, cut holdings to 59 percent of total assets in February, the lowest level since the industry regulator began collecting the data three years ago.
Banamex’s funds are selling peso debt with maturities between three and four years and shifting money into stocks, said Orvananos, who manages 230 billion pesos ($19.2 billion). The funds posted an average annual return of 7.8 percent in the past 36 months, the third-best performer after ING Groep NV’s funds and Afore XXI, according to the regulator, known as Consar.
Mexican inflation slowed to 3.1 percent in the 12 months through mid-March from 3.6 percent in February. The rate is half the 6.1 percent pace in Brazil, the region’s biggest economy, where growth surged to a 25-year high of 7.5 percent in 2010 and fueled a jump in consumer demand. In Mexico, the economy expanded 5.5 percent last year as the U.S. rebound helped drive exports to a record $298 billion.
Mexico’s inflation-adjusted, or real, benchmark rate is 1.4 percent, higher than the rates of -1.5 percent in Russia and - 5.02 percent in Bulgaria, countries that share Mexico’s foreign debt rating of BBB from Standard & Poor’s, according to data compiled by Bloomberg. Brazil, which is rated BBB-, or one level below Mexico, has a real interest rate of 5.65 percent.
Traders expect annual inflation in Mexico to quicken to 3.97 percent over the next five years, according to the yield difference, or breakeven rate, between fixed-rate bonds and debt linked to consumer price increases.
The central bank said Feb. 9 that it expects inflation to end the year within its broader target range of 2 percent to 4 percent as the economy will expand as much as 4.8 percent.
The selloff in bonds is overdone, making yields attractive, because Carstens, 52, will succeed in keeping inflation in check, said Guillermo Osses, the head of fixed-income asset management for emerging markets at HSBC Asset Management. He said he’s been adding to his holdings in recent weeks.
“This is one of the most obvious trades out there,” Osses, who helps manage $8 billion, said in a telephone interview from New York. “Investors are going to regret selling the long end of the curve.”
The traders who are driving up yields will be proven wrong because there’s still slack in the economy that will hold inflation down, Finance Minister Ernesto Cordero said in an interview yesterday at the Inter-American Development Bank’s annual meeting in Calgary.
“The central bank has a lot of credibility and this behavior in the long end of the curve is going to be corrected because of the output gap we have,” Cordero said. “Mexico still hasn’t reached the point of operating at high capacity.”
Surging oil, wheat and corn prices are fueling faster inflation in developing nations from India to China as the global economic recovery strengthens. The UBS Bloomberg Constant Maturity Commodity Index has climbed 7.1 percent this year, extending gains over the past two years to 68 percent.
Mexico’s central bank has left its benchmark lending rate at a record low 4.5 percent since July 2009 to support the economy’s recovery from its worst recession since 1991. Carstens’ peers in Brazil, Chile, Colombia and Peru have all raised borrowing costs at least once in the past year to contain inflation. Argentina and Venezuela don’t set interest rate targets.
Investors are betting that Banco de Mexico, or Banxico, will start raising the benchmark overnight lending rate as soon as July, trading in 28-day interbank rate futures contracts known as TIIE futures shows. Carstens will increase the overnight rate about 75 basis points, or 0.75 percentage point, to 5.25 percent by year-end, according to the contracts.
The central bank’s press office didn’t return a telephone call seeking comment.
Yields on the TIIE futures contract maturing in July rose 1 basis point today to 5.01 percent. In the past five years, the gap between the 28-day TIIE and the overnight rate has averaged 36 basis points.
The peso strengthened 0.2 percent to 11.97470 per dollar, extending its gain to 3.1 percent this year.
The extra yield investors demand to hold Mexican dollar bonds instead of U.S. Treasuries was unchanged at 130 basis points, according to JPMorgan Chase & Co.’s EMBI+ Index.
The cost to protect Mexican debt against non-payment for five years rose 1 basis point to 108, according to CMA DataVision. 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.
One unidentified central bank board member argued during the most recent policy meeting, held March 4, that the bank should warn people about the possibility that interest rates may change, according to minutes released on March 18.
The minutes were more “hawkish” than previous central bank statements, indicating that policy makers may boost rates in the next few months, said Siobhan Morden, chief Latin American strategist at Royal Bank of Scotland Group Plc in Stamford, Connecticut. She recommends investors sell notes with maturities of between one and two years.
Yields on securities due in December 2012 have climbed 63 basis points in the past five months to 5.5 percent. Yields on the bonds due in 2024 have surged 148 basis points over that time to 7.83 percent, compared with increases of 61 basis points on Brazilian debt and 74 on Treasuries.
Kieran Curtis, who helps manage about $2 billion in emerging-market debt at Aviva Investors, said international investors are more bullish on Mexican bonds than locals.
“It seems like a bit of a standoff between foreigners who think it’s very cheap and locals who don’t think their bond markets are that interesting,” Curtis said in a telephone interview from London. “This certainly is not a market I would want to be underweight on at the moment.”
Pension funds had 797 billion pesos, or 59 percent of total assets, invested in local government debt in February, down from 800 billion pesos, or 67 percent, a year ago, according to Consar. Pension funds hold about 21 percent of government bonds, according to the central bank. Bond holdings sank as a percent of total assets because the funds’ money under management jumped 16 percent to 1.383 trillion pesos in the past year.
Bonds to Stocks
The funds boosted investments in international equities to a record 9.5 percent and holdings of corporate domestic debt to 18 percent, according to Consar.
“This has been a good year for inflation, but it’s hard to think it will slow to 3 percent,” Banamex’s Orvananos said. “The breakeven for inflation continues to be stuck near 4 percent.”