Pimco’s QE3 Distaste Grows as Peso Bond Bet Fades: Mexico Credit

Pimco Co-CIO Bill Gross
Pacific Investment Management Co. (PIMCO) co-chief investment officer Bill Gross. Photographer: Andrew Harrer/Bloomberg

Bill Gross’s concern that Ben S. Bernanke is sparking a jump in U.S. consumer prices is already sinking his bet in Mexican peso bonds.

Yields on Mexican benchmark notes due in 2024 soared to a three-month high of 5.73 percent on Sept. 14, a day after the Federal Reserve announced a third round of asset purchases aimed at boosting economic growth. Yields have jumped 59 basis points, or 0.59 percentage point, from a record low July 20 and erased almost all the gains in the debt since Gross said in a June 19 post on Pacific Investment Management Co.’s Twitter account that he favored Mexican bonds over German bunds. German yields have climbed 47 basis points in the same period.

Mexican bonds, the most correlated with U.S. debt among Latin American local-currency notes, are mirroring a selloff in Treasuries as the Fed’s move leads investors to shift to higher-yielding assets. Mexican debt yields 1 percentage point less than the average for Latin America, according to JPMorgan Chase & Co. The rout in Mexican bonds is also undermining Gross’s aim to profit from yields that are higher than German and U.S. debt and a nation with 50 percent less debt than the euro region.

“With this new cash injection, investors are trying to get into slightly more risky assets that offer greater returns,” Alejandro Padilla, a debt strategist at Grupo Financiero Banorte SAB, said by telephone from Mexico City. Mexican bonds are falling because Mexico has turned into a “safe haven trade.”

Mark Porterfield, a spokesman for Pimco, declined to comment on the company’s Mexican bond holdings.

Treasury Holdings

Yields on benchmark Treasuries touched a four-month high of 1.87 percent on Sept. 14 after the Fed said last week it will expand its holdings of long-term securities with open-ended purchases of $40 billion of mortgage debt a month in a third round of quantitative easing, known as QE3.

In August, Gross, who runs the world’s biggest bond fund, cut his holdings of U.S. Treasuries to the lowest since October. He said in a Twitter post on Sept. 12 that more stimulus from the Federal Reserve will lead to a resurgence of inflation.

The 30-day correlation coefficient between Mexican peso bonds and Treasuries rose to 0.67 yesterday from 0.56 a month earlier, according to data compiled by Bloomberg. It touched a 20-month high of 0.73 on Sept. 4. A reading of 1 means the two securities move in lockstep.

Debt Load

“We’re staying out of long positions” on peso bonds, Roberto Ivan Garcia Castellanos, a fixed-income trader at Casa de Bolsa Finamex SAB in Guadalajara, Mexico, said in a telephone interview from Mexico City. “The market is moving tick-for-tick with Treasuries.”

Mexico’s lower debt levels and higher yields made investing in the nation’s bonds instead of German notes a decision so obvious to Gross that he ended his June comments on the Pimco Twitter account with the word “duh.”

Government debt will equal 42.9 percent of Mexico’s gross domestic product this year, versus 90 percent for the euro area, according to International Monetary Fund projections.

The Mexican economy will grow about 3.8 percent this year, about twice as fast as the U.S., according to economists surveyed by Bloomberg. They anticipate that Europe will contract by 0.25 percent in 2012.

Alberto Bernal, head of fixed-income research at Bulltick Capital Markets, says a rally in the Mexican peso triggered by demand for riskier assets will boost dollar-based returns for investors in local debt, making the bonds a buy.

‘Fully Consistent’

The Mexican peso, which climbed 2.4 percent against the dollar in the two days after the Fed’s announcement, will rally 6.4 percent more to 12 pesos per dollar by year-end, according to Bernal. Yields on bonds due in 2024 will drop 70 basis points to 5 percent, he estimated.

“My thesis is fully consistent with being long the longest possible Mexican bond you can find in pesos,” Bernal said in a telephone interview from Miami. Foreigners buying peso bonds would be “investing in a currency that will appreciate.”

The peso weakened 0.5 percent to 12.8373 per dollar at 12:44 p.m. in Mexico City.

The extra yield investors demand to own Mexican government dollar bonds instead of U.S. Treasuries rose three basis points to 157 basis points, according to JPMorgan.

The cost to protect Mexican debt against non-payment for five years rose one basis point to 87 basis points, data compiled by Bloomberg show. 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.

QE2 Precedent

The last time that the Fed announced quantitative easing measures, peso bonds also lost value.

Yields on 10-year Treasuries jumped 44 basis points in the month after the Fed announced QE2 on Nov. 3, 2010. Peso bond yields soared 73 basis points during the same period.

“People still have QE2 on their minds,” Banorte’s Padilla said. “We’re seeing something similar this time.”

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