UBS's Top 2016 Trade Starts Year Flying as Mexican Peso Tumblesby and
Peso is worst performer this year among most-traded currencies
UBS advises shorting peso, wagering on lower interest rates
The Mexican peso is tumbling so much and so fast that one of UBS Group AG’s most-touted emerging-market trades for 2016 is already halfway to its return target.
The success of UBS’s recommendation to bet against the currency reflects how a country that was once seen as an emerging-market bright spot is now starting to catch up to a selloff that sparked losses of at least 25 percent last year in Brazil, Colombia and South Africa. The peso’s 6 percent drop this year is the worst among its most-traded peers as concern mounts that the rout in oil prices will worsen the current-account deficit in a nation that UBS says is over-reliant on funds from foreign investors.
Championed by star investors from Michael Hasenstab to Bill Gross since the historic reform to end the nation’s oil monopoly in 2013, the peso has been nothing but a disappointment as it weakened three consecutive years. While economists agree that Mexico is in better shape than countries that are more reliant on commodity exports and China, the peso is especially vulnerable to global bearish sentiment on developing nations because its liquidity mean traders can easily use it as a proxy hedge.
“Mexico is the least worst story in emerging markets, but it is not as strong as perceived,” said Bhanu Baweja, who correctly predicted the selloff in developing-nation currencies last year and is the head of emerging-market cross-asset strategy at UBS in London. “There’s no reason to expect the peso to appreciate.”
Baweja recommended Nov. 17 that clients sell the peso against the dollar, paired with a bet that Mexico’s interest rates will decline. UBS, the fifth-biggest foreign-exchange trader, according to Euromoney Plc, billed it as one of the 10 best ideas for 2016. Since then, the peso has lost 8.2 percent on a total return basis. Forwards contracts that reflect traders’ expectations of what the one-year rate will be in 12 months have declined to 4.4 percent, from 4.8 percent.
The peso tumbled to a record low of 18.8024 per dollar last month as the plunge in oil prices dims the prospect for investment in Mexico’s energy industry, while growth in the U.S., its major export market, is losing momentum. The slump prompted Mexico’s central bank on Jan. 28 to extend through March a program of offering daily dollar auctions to shore up the peso.
The currency fell 0.6 percent as of 12:58 p.m. in New York, heading for a sixth weekly decline over the past seven weeks.
Alejandro Silva, a partner at Chicago-based Silva Capital Management, said the peso’s swift decline has caught him by surprise. He blamed the drop on its use as a hedge and on lower oil prices, which reduce the government’s revenue and spending. The peso is the world’s most-traded emerging-market currency.
“When a wave of volatility comes, the peso is one of the worst hit,” said Silva, who helps oversees $180 million of assets.
To Baweja, Mexico’s trouble goes beyond oil and global emerging-market sentiment.
The deficit in the country’s current account, the broadest measure of trade in goods and services, may reach 2.6 percent of gross domestic product this year, a level last seen in 2000, according to the median forecast of economists surveyed by Bloomberg.
The shortfall means the country relies on foreign capital for financing. With overseas investors already holding $85 billion in peso-denominated fixed-rate debt, or 59 percent of the total, capital inflows are likely to slow and might even reverse, according to Baweja. The percentage of foreign ownership in Mexico’s bond market is the highest among major developing nations, and compares with 19 percent in Brazil and 22 percent in Turkey, according to Bank of America Corp.
Foreign investors have flocked to Mexico in recent years as President Enrique Pena Nieto’s reforms in the financial, telecommunications and energy industries sparked optimism that he may unleash a surge in growth. Its close ties to the U.S. also fueled speculation that the recovery in the world’s biggest economy would lift Mexico’s exports.
While Mexico’s growth accelerated over the past two years, it has fallen short of the government’s and analysts’ projections. The economy expanded 2.5 percent last year, trailing the 3.4 percent median forecast of economists surveyed at the beginning of 2015.
Even so, there’s no shortage of peso bulls. Bernd Berg, an emerging-market strategist at Societe Generale SA in London, recommended buying the peso on Jan. 27, saying it’s “significantly undervalued” and Mexico has “the best fundamentals in the EM universe.”
Franklin Templeton Investments’s Hasenstab, who oversees $130 billion in assets, said in October that the peso presented a buying opportunity not seen in decades. Since his comment, the peso has dropped 8 percent. Gross, a billionaire investor at Janus Capital Group Inc., said on Jan. 20 that the peso may be the “most attractive long shot.”
Press officials at Templeton and Janus didn’t immediately respond to requests for comment on the outlook for the peso.
Baweja said his peso trade may end up gaining even more than the 15 percent return target. A weaker Chinese yuan may erode the competitive edge of Mexico, which has been winning its share of global exports in recent years, he said.
“There’s a possibility of the peso overshooting” to the downside, Baweja said. “An undervalued currency can get cheaper.”