From JR Crooks: Mexicans working on a small tomato farm in Southwest Florida can’t compete with Mexicans working on tomato farms in Mexico.
That’s what one farm owner said is the biggest hurdle for his farm. Not the current wet conditions that might cause his tomato plants to rot.
People often cite growth in U.S. exports of cash crops like corn and soybeans to prove that free-trade agreements have served the U.S. economy well.
But consider the tomato …
It’s one example of why the Trump administration is reconsidering our trade agreements. Right now, all eyes are on the North American Free Trade Agreement. That’s because second-round talks to revamp NAFTA kicked off in Mexico City today.
Critics worry that President Trump essentially wants to put up an economic wall between the U.S. and Mexico.
Right or wrong, that’s a wall of worry the U.S. market seems ready to climb. But for Mexico, Trump’s planned 30-foot-tall border wall promises less of a hurdle than its financial counterpart.
After the November 2016 election, the Mexican peso plunged on the idea that Donald Trump was going to wreak havoc on U.S. immigration policy and trade relations.
As the chart below suggests, those fears were substantially overblown.
True, the peso dropped 17% in just two months after Trump was elected. Yet it marched back strongly, more than recovering its post-election losses.
But markets do get ahead of themselves, and the currency market is no exception.
To be sure, much of the peso’s recovery was driven by the greenback. Futures on the U.S. Dollar Index dropped 10% year-to-date. That trade seems crowded and due to unwind.
When it happens, it will hurt the peso.
At the same time, Mexico’s central bank wants to end its rate-hiking cycle that has increased its benchmark interest rate by 400 basis points since December 2015. This underpinned the peso and helped ease inflation fears.
That’s good. Except that a significant 35% of Mexican debt is held outside of Mexico. A stronger peso reduces that exposure. But it also makes Mexican exports costlier. And roughly 80% of Mexican exports go to the United States.
Mexico’s oil exports, for example, jumped 34% in the second quarter when the peso was trading between 8% and 22% lower than current levels. That could be a game-changer, eating into near-term growth expectations.
Add in fresh rhetoric about how much the U.S. needs a wall and how NAFTA is a very, very bad deal.
That’s a reason to rethink the Mexican peso trade. And Mexico’s stock market, too.
There is a solid correlation between Mexico’s currency and its stock market. Typical, since emerging-market economies depend on sentiment and capital flows to a larger degree than developed markets do.
Traders who look for near-term buy and sell setups, but don’t dabble in forex or futures, should consider betting against the iShares Capped Mexico ETF (EWW).
For the next two months, here’s the game plan …
U.S. economics and policymaking might align to create conditions that favor the U.S. over Mexico. If so, betting against Mexico makes sense now … or at first sight of downside momentum.
Looking further down the road, however, a pullback in Mexican markets is probably a buying opportunity.
The Bank of Mexico just increased its GDP estimates for Mexico’s economy this year and next. It expects GDP to run between 2% and 3% each year.
Current conditions are constructive for Mexican growth potential. The significant risk, of course, is what might come from NAFTA talks. Volatility is certainly possible, even likely.
But even if NAFTA negotiations fall apart, I don’t expect trade between the U.S. and Mexico will deteriorate meaningfully and suddenly. Last resort, terminating NAFTA would put Mexican trade under the purview of the World Trade Organization until new arrangements are made. And Mexican officials don’t appear concerned by that outcome.
In the meantime, a bet against Mexico today — even if no one leaves the negotiating table before this round of talks ends on Tuesday — might thrive on the uncertainty.
The iShares Capped Mexico ETF (NYSE:EWW) closed at $56.76 on Friday, up $0.29 (+0.51%). Year-to-date, EWW has gained 30.49%, versus a 11.90% rise in the benchmark S&P 500 index during the same period.
This article is brought to you courtesy of The Edelson Institute.