Wall Street's Love for Mexican Bonds Tempered by Hedging Costs

  • Foreign holdings of Mbonos slide to lowest in six months
  • Meanwhile, Morgan Stanley bets on a rally of local bonds

Some of the largest Wall Street firms are betting on a rally of Mexican local bonds. Not everyone is heeding the advice.

Foreign holdings of peso-denominated government debt have dropped to an almost six-month low of 62 percent after surging to the highest level on record in March, according to Mexico’s central bank data through May 25. Meanwhile, a surge in costs to protect traders’ profits is curbing their appetite for the so-called Mbonos.

“A foreigner leaves when their investment is too volatile or they don’t have the capacity to hedge their peso exposure,” said Alejandro Urbina, who helps manage $180 million of emerging-market debt at Silva Capital in Chicago. “Considering market conditions, the drop in holdings seems low to me.”

Morgan Stanley and Stone Harbor Investment Partners have picked peso-denominated assets as favorites, arguing that they’ve been punished too harshly and are bound for gains. In the meantime, international investors have been trimming their positions on Mexican local bonds as the currency rebounds from last year’s plunge. The peso went from the second-worst performer among major peers in 2016 to a world-beating rally this year amid softer trade rhetoric from White House officials and higher borrowing costs.

Bond investors who are concerned about the currency risk typically sell the peso in the forward market to lock in an exchange rate through a trade known as “swapito.” The heightened currency volatility and an increase in benchmark interest rates have sent the costs of hedging to such high levels that the yields in 10-year Mbonos could be wiped out, according to data compiled by Bloomberg.

People are not going to pay up to cover volatility if they sense the Mbono’s gains are done, said Pedro Tuesta, an economist at research company 4cast Ltd.

"So far, there’s no border wall, there’s no Nafta tear-up," Tuesta said from Washington, D.C. "All that news has been priced in, so there are no more gains here."

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