Junk Tax-Fueled Inflation Swells Gap to U.S. Debt: Mexico Credit

Surging inflation and the prospect the U.S. Federal Reserve’s reduction of monetary stimulus will spark outflows from developing countries are prompting investors to demand a bigger premium to invest in Mexican bonds.

The country’s 2042 peso notes yield 3.95 percentage points more than similar-maturity U.S. Treasuries, the biggest gap since since Dec. 4, according to data compiled by Bloomberg. The spread was within 0.04 percentage point of an 18-month high.

The selloff in Mexican debt triggered by the Fed’s decision to scale back asset purchases deepened yesterday as a report showed that annual inflation soared to a seven-month high in Latin America’s second-biggest economy. The jump in consumer prices was fueled by new taxes on everything from dog food to soft drinks that the government imposed this month as part of an effort to reduce its dependence on oil revenue.

The report “confirmed that inflation continued worsening due to the tax effects of the fiscal reform,” Alejandro Padilla, a strategist at Grupo Financiero Banorte SAB, said in a telephone interview from Mexico City. “It’s a significant increase. Investors are still concerned that tapering could generate outflows from emerging markets.”

Prices climbed 0.68 percent in the two weeks to Jan. 15, compared with the 0.6 percent median forecast of 20 analysts in a Bloomberg survey. Annual inflation quickened to 4.63 percent from 4.09 percent, above the 4 percent upper limit of the central bank’s target range.

The peso weakened 0.4 percent today to 13.4499 per dollar as of 3:48 p.m. in New York.

Growth Pickup

Escalating violence in the farming state of Michoacan is also adding to speculation about a pickup in inflation, with vigilante farmers battling drug gangs and the government moving to try to restore order. The Pacific state is Mexico’s second-biggest lime producer, third-largest for tomatoes and the top producer of avocados.

Yields on the 2042 bonds rose nine basis points, or 0.09 percentage point, to 7.72 percent today, pushing the increase to 71 basis points in the past three months, according to data compiled by Bloomberg.

A pickup in Mexican economic growth this year may further stoke inflation, prompting policy makers to boost interest rates, according to Barclays Plc.

Gross domestic product will expand 3.4 percent in 2014, about twice the pace in 2013, according to a Bloomberg survey of 29 economists. Swaps traders see a 64 percent chance of an increase in the 3.5 percent benchmark rate in the next year, up from 44 percent a month earlier, according to data compiled by Bloomberg.

Fed Taper

“Inflation dynamics could enter an acceleration process if, in fact, economic activity rebounds strongly,” Marco Oviedo, an economist at Barclays, wrote in an e-mailed note yesterday. As policy makers have “become more active in macroeconomic stabilization, we believe that a hiking cycle could come sooner rather than than later.”

While the central bank will stay on hold at its next meeting Jan. 31, it’s likely to show a “hawkish bias,” he said. Mexico’s central bank cut the rate 1 percentage point in 2013 to stoke growth.

Ricardo Medina Macias, a spokesman for Banco de Mexico, declined to comment on interest-rate expectations.

Banorte’s Padilla recommends investors buy inflation-linked bonds due in 2016 to profit from the increase in consumer prices.

“There’s an expectation that inflation will stay under pressure in the coming months,” Padilla said.

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