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Inflation-Bond Laggards Lure Record Auction Bids: Mexico Credit

Mexican inflation-linked bonds are at their cheapest in two years relative to fixed-rate debt, sparking record demand for the securities at government auctions.

Debt tied to consumer prices due in three years drew 14.3 billion pesos ($1.2 billion) of bids at yesterday’s auction, almost seven times more than the 2.1 billion pesos offered, the central bank said.

Demand for the securities is rebounding after the slowest inflation in almost five years caused the bonds to underperform. The yield gap between inflation-linked and fixed-rate bonds due in 2014, a gauge of investor expectations for price increases, shrank to a two-year low of 3.42 percent on June 1. While countries from Brazil to Peru have raised interest rates to curb inflation, Mexico is the only major Latin American nation to keep them unchanged in the past year.

“It sounds like a good time to take advantage of the underperformance of inflation-linked debt,” Javier Belaunzaran, who helps manage about 40 billion pesos at Interacciones Casa de Bolsa SA, said in a telephone interview. “The paper is cheap. Traders are jumping ahead and trying to take advantage of the lack of performance in the past.”

Mexican bonds that protect against price increases returned 1.8 percent this year through June 6, compared with an average 7 percent gain for inflation-linked debt sold by Latin America countries, according to Barclays Plc indexes.

The yield on Mexico’s bonds tied to the consumer price index fell five basis points, or 0.05 percentage point, since the end of February to 1.96 percent, according to data compiled by Bloomberg. Yields on the country’s fixed-rate bonds due in 2014 fell 60 basis points during the same period to 5.84 percent.

U.S. Slowdown

Annual inflation slowed to 3.3 percent in mid-May from 4.4 percent in 2010 and touched a five-year low of 3.04 percent in March. Inflation in Brazil climbed to 6.55 percent in May, the highest since 2005, a government report showed yesterday.

Speculation the slowdown in the U.S. economy will erode demand for Mexican exports is curbing expectations for price increases in the Latin American country, causing inflation-linked debt to underperform, said Jorge O. Mariscal, director of investment research at the Rohatyn Group, which manages $3 billion.

In the U.S., which buys about 80 percent of Mexico’s exports, manufacturing grew in May at the slowest pace in more than a year and the jobless rate unexpectedly climbed to 9.1 percent. Mexico’s economy grew 4.6 percent in the first quarter, less than the 5 percent median forecast in a Bloomberg survey of 17 analysts.

‘Becomes Cheaper’

“We’ve seen some concerns on the outlook for U.S. growth having an impact on the outlook for growth in Mexico,” Mariscal said in a telephone interview in New York. “Typically what happens in this environment when people are worried about growth is that inflation becomes less of a concern. Therefore, inflation-protection bonds will become more attractively priced. So it’s a good buying opportunity because it becomes cheaper.”

Alejandro Urbina, who helps manage and advise about $800 million in investments at Silva Capital Management LLC in Chicago, said he favors fixed-rate debt because it will keep outperforming inflation-linked bonds.

“It’s one of those situations where the market was too focused on the U.S. recovery and they got sucked in by their optimism,” Urbina said in a telephone interview. “The traders saw an inflation problem. It never materialized, at least not in Mexico.”

Extra Yield

An official at the Finance Ministry didn’t return calls for comment.

The extra yield investors demand to hold Mexican government dollar bonds instead of U.S. Treasuries widened 3 basis points to 146 basis points at 5:05 p.m. New York time, according to JPMorgan Chase & Co.

The cost to protect Mexican debt against non-payment for five years rose two basis points to 107, 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.

The peso dropped 0.8 percent to 11.8453 per dollar.

Yields on TIIE interest-rate futures contracts maturing in December were unchanged at 5 percent, indicating the bank will raise borrowing costs by then.

Policy makers kept the benchmark lending rate at a record low 4.5 percent last month amid a “moderation in the pace” of the economic expansion, according to a policy statement.

‘Quite High’

Demand for inflation-linked bonds is recovering as investors seek to tap into a rally in the peso and profit from rate differentials with the U.S., said Sara Zervos, who manages $10 billion in emerging-market debt at Oppenheimer Funds Inc. in New York. The Federal Reserve has held its key rate at zero to 0.25 percent since December 2008.

International investors bought $21 billion of Mexican debt denominated in pesos in the six months through March, the most since the central bank began compiling the data in the 1960s.

“Demand for Mexican bonds in any variety is quite high,” Zervos said in a telephone interview. “Mexico is very attractive because of the higher interest rates relative to the U.S. I really don’t think there are inflation fears at work behind the demand for the Udibonos. It’s more they’re seeking more exposure to local Mexico.”

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