BNP Tells Traders to Exploit El Nino With Mexico Inflation Wager

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With Mexico’s inflation rate sinking to a nine-year low this month, bond traders are naturally showing scant concern consumer prices will pick up any time soon.

That’s a mistake to BNP Paribas SA. It’s predicting El Nino -- a global weather pattern that typically causes droughts, wildfires and floods -- will reverse a slide in agricultural prices and boost the inflation rate in as little as six months. The Paris-based bank recommends investors bet on cost-of-living expectations rising in the bond market.

BNP has history on its side as past El Nino episodes have pushed up global food prices and fueled the biggest inflation surges in Mexico and Brazil, according to a paper last month by researchers at the International Monetary Fund and the University of Cambridge. An increase in the cost of food, which accounts for more than 20 percent of Mexico’s consumer price index, would help push up annual inflation from 2.93 percent in the first half of May.

“El Nino will be a fundamental factor, as this will represent an exogenous shock to the Mexican market,” BNP fixed-income strategists Gabriel Gersztein and Gustavo Mendonca said in an e-mail. “The Mexican market is not isolated from the rest of the world, so a rise in agricultural prices will naturally impact food prices in Mexico, leading markets to price in this effect.”

Bond Spread

The yield gap between inflation-linked peso bonds due June 2016 and similar-maturity interbank rate futures was 2.96 percent on Tuesday, up from 2.73 percent the day before BNP published its recommendation May 21, data compiled by Bloomberg show. The difference -- a proxy for the break-even inflation rate -- will swell from last week by as much as 0.4 percentage point this year, the bank said in the report.

Mexico’s peso dropped 0.2 percent to 15.3302 per dollar Wednesday as of 2:15 p.m. in New York.

The Australian Bureau of Meteorology joined the U.S. Climate Prediction Center and Japan Meteorological Agency this month in declaring that sea-surface temperatures in the equatorial Pacific are high enough -- and the atmosphere above the ocean has reacted strongly enough -- to mean an El Nino has begun.

Commodity prices including for foodstuffs typically rise in the wake of El Nino, according to the IMF working paper in April, which examined the impact on 33 countries from 1979 to early 2013. The weather phenomenon also tends to bolster economic growth in countries including Mexico and the U.S., said co-authors Paul Cashin and Mehdi Raissi of the IMF as well as University of Cambridge economist Kamiar Mohaddes.

Stoking Inflation

A stronger expansion and higher food prices can stoke inflation in Mexico, Raissi said in an e-mail. Previous El Nino events added an estimated one percentage point to Mexico’s inflation after two quarters, tied with Brazil for the largest accumulated increase in that period, according to the report.

To Barclays Plc economist Marco Oviedo, wagering on rising Mexican inflation may turn out to be a losing bet. Price increases in Mexico are moderating after policy and legal changes that have led to smaller gasoline price increases and reduced rates for telephone services, he said.

Oviedo actually lowered his year-end inflation forecast to 2.6 percent from 2.8 percent last week. The central bank, which declined to comment on El Nino’s potential impact on living expenses, also forecasts less than 3 percent.

‘Very Low’

“It’s going to be business as usual on the perishable side,” he said by telephone from Mexico City. “What is new is that telecommunications prices will continue to decline, gasoline prices are not going to affect inflation in the coming months and core inflation is going to remain very low.”

Still, most economists expect inflation to tick up by the end of the year. The median estimate of 27 analysts in a Bloomberg survey is for consumer prices to rise to an annual rate of 3.2 percent by the end of the year.

“We haven’t incorporated El Nino in our model yet but it could have an effect,” Luis Adrian Muniz, an economist at Vector Casa de Bolsa, said by telephone from Mexico City. “We’re already expecting that the price declines in farm and ranch goods, which have helped bring down inflation in recent months, will reverse later this year and turn into upward pressures.”

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