Mexico’s Financial Stability Seen at Risk as BNP Says Intervene

  • Analysts weigh risk of dollar sales and emergency rate hike
  • Bonds fell and the decline of the peso accelerated this month

Mexico’s financial stability is hanging in the balance as the peso’s tumble prompts a dangerous acceleration in outflows from the nation’s bonds, according to BNP Paribas SA.

A pullback by foreigners is particularly worrisome for authorities, who have often cited peso bond holdings by international investors as a sign of stability. Central bank policy makers will now have to act soon, BNP analysts said in a note on Friday. Separately, Citigroup Inc. and Barclays Plc said the peso’s plunge could prompt another surprise rate increase after policy makers unexpectedly raised the benchmark in February outside of a regularly scheduled meeting.

The mounting speculation that Mexican authorities will be forced to act imminently to bolster the peso comes after the currency’s declines have accelerated this month, pushing it to a level that BNP says is at least 8 percent undervalued. The extra yield that investors demand to hold Mexican government peso debt rather than U.S. Treasuries has surged this month and the securities have lost 8.8 percent in dollar terms, according to Bloomberg indexes.

“The market is demanding a higher premium to hold Mexican assets and Banxico will be forced to deliver this,” wrote BNP analysts Gabriel Gersztein, Gustavo Mendonca and Samuel Castro, who say the peso is as much as 9 percent undervalued at current levels. “Carry no longer compensates for the expected currency risk.”

Still, as bad as May has been for bond investors in Mexico, it’s still considered a safe-haven for many drawn by the prospects of faster growth in Latin America’s second-biggest economy, which is expected to expand for a seventh year. Last month, Moody’s Investors Service reaffirmed the nation’s credit rating of A3, the seventh-highest investment grade.

Central bank Governor Agustin Carstens surprised the market on Feb. 17 by selling $2 billion directly to banks and unexpectedly increasing the key rate by 0.5 percentage point. Since then, the bank has avoided tapping reserves to contain recent currency weakness.

In the case that an initial attempt by authorities to drive out speculators by selling reserves fails, policy makers may be forced to increase the overnight rate, BNP Paribas analysts wrote.

The trigger for intervention and an intra-meeting rate increase may be if the peso weakens close to 19 per U.S. dollar, Barclays analyst Marco Oviedo said in an e-mail on Friday. The most likely scenario is an increase of 0.5 percentage point at the central bank’s June 30 meeting, he said. The currency gained 0.2 percent today to 18.3794 per U.S. dollar as of 11:00 a.m. in Mexico City.

“It’s plausible for Banxico to once again consider a combination of discretionary USD sales and emergency rate hike,” Citigroup strategists Kenneth Lam and Dirk Willer said in a note to clients.

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