Pesos And Pork Bellies

Soon, pork bellies, live cattle, and such won't be the only volatile commodities trading on the Chicago Mercantile Exchange. On Apr. 25, Merc pit traders are expected to start shouting out orders for Mexican pesos again. Reviving a peso futures market is just one of many measures being taken that could restore some stability to the battered peso, which has lost half its value since it was first devalued last December. The volatility has wreaked havoc on Mexican trade and investment.

Mexico's experts are betting that futures trading will calm the markets by making the peso's value more predictable. "The futures market is an essential complement to a floating peso," says Francisco Gil Daz, a deputy governor of the Bank of Mexico, the central bank. "Right now, an exporter doesn't know whether he'll receive 5, 10, or 15 pesos per dollar six months from now. That makes planning, production, and costing very difficult."

Futures will also let equity investors with big positions in Mexican stocks breathe a little easier, since they will be able to hedge their peso holdings. That will be a big plus for any foreign investors bold enough to wander back to the Bolsa. Although the market index has recovered to around 1900 from a low of 1445 in February, investors still have seen 36% of their portfolios wiped out since January by the combined peso and stock market crashes. And if the new futures scheme works, it could even help pare Mexican interest rates, which at staggering 90% levels include a 40% spread to compensate for political and exchange risk.

Encouraging peso futures trading is the latest in a series of moves Mexico has made to salvage its economy. By jacking up interest rates and raising taxes, the government has brought Mexico's current account into balance after a gaping deficit precipitated the peso panic last year. In February, Mexico even racked up a $450 million trade surplus. Delivery of $5.2 billion in U.S. loans and $7.73 billion in aid from the International Monetary Fund is also helping to calm the markets. As a result, the peso, which had reached 7.2 to the dollar at the height of speculation, has stabilized at around 6.5.

MIXED SIGNALS. But improved numbers hide persistent imbalances in the economy. If the trade account is in surplus, it's mainly because Mexico can't afford many imports, now twice as expensive as they were four months ago. Also, the trade surplus is masking continuing capital outflows. Reserves dropped by about $2 billion in March as foreign investors continued to cash in their holdings. And renewed calls by Republicans in Washington to withhold further loans from Mexico are sending tremors through the skittish investment community.

In theory, anyway, allowing futures trading should ease some of the anxiety by fixing the value of a peso contract. Buyers and sellers can reduce risk through hedging, eliminating gains or losses due to currency movements. Businesses and investors can get an idea of the peso's actual value at a future date.

In Chicago, meanwhile, the Merc expects a growing business in the contracts, even if they start out rather small. The exchange handles around 44,000 yen contracts and about 8,000 Canadian dollar contracts each day, and it's expected to handle only 1,000 peso contracts daily when the market starts up. But analysts predict that as many as 5,000 peso contracts--each worth 500,000 pesos--could be trading daily within six months.

The new trading is history repeating itself. The Merc operated a small Mexican peso futures market from 1972 to 1985. But in 1982, Mexico's foreign-debt debacle threw the economy into turmoil. Central bankers ended trading after concluding that low-volume speculation on the peso's price was only skewing its value.

After the debt crisis, Mexican officials pegged the peso to the U.S. dollar, programming its gradual devaluation. Then, for three years, the peso was kept within a carefully controlled trading band adjusted for inflation, and the central bank intervened when necessary to keep the currency stable. But the game was over in December when the government ran out of reserves and let the peso float.

That revived the need for a new means to dampen the peso's wild gyrations. Besides the Merc contracts, Mexico's central bank has come up with other schemes to allow hedging of the peso. Several Mexican and foreign banks have been authorized to offer "forwards," which are tailor-made peso futures transactions designed for individual clients and offered in Mexico. The Mexican Stock Exchange is set to launch a U.S. dollar quotation market, but bureaucratic snafus have delayed the planned Apr. 3 inauguration for about a month. Analysts say that until the peso exchange rate is stabilized and Mexico develops a more sophisticated forward market at home, the Merc will handle most peso deals.

The new contracts already are attracting interest from a wide range of potential customers. Merc officials have fielded inquiries from cattle dealers looking to hedge their exposure in cross-border livestock sales and from equity dealers exposed to peso risk because they are heavily invested in widely traded Mexican stocks such as Telefonos de Mexico. While two-thirds of most currency transactions tend to be speculative, Merc officials think that the strong demand for business-related hedging will create even more liquidity in the market and speed up the peso's stabilization.

NO PANACEA. Major banks and traders are jumping to grab a piece of the futures action. Sakura Dellsher Inc., a Chicago-based trading firm, is planning a seminar in Mexico City at the end of May to educate dealers and users about the market. Harris Futures Corp. in Chicago, a unit of Bank of Montreal, has held seminars in Chicago for a half-dozen Mexican banks to help familiarize them with the concept of currency futures and options on futures.

But even purveyors of the new contracts recognize they don't address Mexico's fundamental ills. Says Anthony D. McCormick, president of Harris Futures and vice-chairman of the Merc's foreign-currency committee: "In the end, the value of the currency will be derived from the political environment and monetary and central bank policy." Leo Melamed, chairman and CEO of Sakura Dellsher and an ex-Merc chairman, notes that the launch of a peso futures market "is far from a panacea. It's going to fall far short" of curing centuries of Mexican ills.

One big technical risk the new market will face is that sentiment may still be so negative that peso sellers will far outnumber buyers. That could drive the currency even lower once trading starts. But Mexican officials figure the risk of speculation pales in comparison with the benefits of a widely traded peso market. "Speculation is already there," says the central bank's Gil Daz, with a sigh. "Today, the big transnational companies are very nervous about the volatility of the exchange rate." But with the futures market in place, he adds, "they're going to bring in many more dollars, and things will be much calmer."

Mexican officials know they need to buy more time. "The markets have been very extreme in their judgments," protests Ariel Buira Seira, another deputy governor of the central bank. "Six months ago, we were the darling of the market, and Mexico was said to have one of the best economic teams in the world. Then, they went to the opposite extreme. This is very unfair, of course." Fair or not, it's reality in these days of the fickle global investor. The more market-stabilizing mechanisms that Mexico can draw on, the better.


-- Help exporters and importers set prices by formalizing exchange-rate expectations

-- Limit equity market volatility by letting stock investors hedge their peso-denominated holdings

- Help lower Mexican interest rates by reducing the risk premium for exchange-rate uncertainty and political instability


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