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Traders Clamor for Protection as Mexico Inflation Pressure Grows

·4 min read

(Bloomberg) -- Increasing skepticism over Mexico’s ability to keep a firm lid on price pressures over the next few years is boosting the appeal of the nation’s inflation-protected assets.

Five-year breakevens, a measure of inflation expectations based on index-linked bonds, surged to the highest since 2015 on Thursday, even after the central bank, known as Banxico, hiked interest rates twice this year. The breakevens price in inflation of nearly 4.8% in five years time, above Bank of Mexico’s 2-4% target range.

The move is part of a regional trend as an economic rebound and rising energy costs drive up prices, but is exacerbated in Mexico by concern that the proposed new leadership at the central bank under Arturo Herrera will lead to a more dovish approach to inflation. The nation is expected to deliver the smallest amount of hikes in Latin America over the next 12 months, according to swap rates.

As prices jump, investors are flocking into inflation-linked Udibonos and dumping nominal bonds, with yields on Udis due December 2025 hovering around or below 2% over the past month, compared with 2.24% on June 30. Yields on nominal peso bonds due March 2026 have climbed to 6.8% from 6.39% over the same period.

“When inflation rises, market operators tend to put pressure on long-term breakevens, it’s a knee-jerk reaction,” said Benito Berber, an economist at Natixis in New York. It’s also possible “that the market’s perception is that this Banxico, and the new one under Herrera, are willing to tolerate higher inflation.”

Herrera, a former finance minister, has been nominated to take over as central bank governor by President Andres Manuel Lopez Obrador. He’s expected to assume the post next year, and will be the fourth Lopez Obrador appointee on the board, marking a dramatic shift for what was once among the most hawkish monetary institutions in the developing world.

Bona Fides

The inflation fears aren’t confined to Mexico. Latin American peers including Brazil and Chile have also seen five-year breakeven rates climb to the highest in years.

An economic recovery after a major global recession is likely to boost inflation expectations worldwide, but Mexico will have to work twice as hard to convince markets of its hawkish bona fides.

It’s a tough sell with Mexican inflation having strayed well beyond the central bank’s upper limit. On Thursday, bi-weekly figures showed consumer prices climbing 5.9% year-on-year, with both headline and core inflation exceeding expectations.

The rising pressures on merchandise inflation are “concerning,” Citigroup wrote in a client note after the data release. Price risks are “tilted to the upside” and the inflation rate will probably finish the third quarter at 5.8%, above Banxico’s latest projection of 5.6%, according to the report.

“Mexico’s inflation dynamics have deteriorated considerably,” said Carlos Capistran, an economist at Bank of America in New York. “There’s a lack of a clear explanation from the central bank of it’s position on returning inflation to target, since currently there seem to be two groups with different views within Banxico.”

Elsewhere in the market, Mexican corporate bonds mostly weakened this week, joining losses in both sovereign peso-denominated and dollar-denominated bonds.

Mexico’s TIIE swap rates climbed across the board, extending their uptrend throughout September. Two-year swap rates led gains among all tenors, soaring 17bps since last Friday, in line with higher Treasury yields and Mexico’s higher-than-expected mid-September inflation. The curve now prices in rate hikes of almost 60 basis points before year-end, with three policy meetings left.

Next week, all eyes will be on the central bank, where policy makers are expected to lift the benchmark lending rate by 25 basis points to 4.75%. Mexico will also report trade balance, economic activity, unemployment and budget balance figures.

WHAT TO WATCH:

  • Sept. 27: Trade balance, economic activity

  • Sept. 28: Unemployment rate, international reserves

  • Sept. 30: Net outstanding loans, overnight rate, budget balance

  • Oct. 1: Markit Mexico PMI

BOND SALES:

  • Fibra Uno to sell up to 8.1b pesos of local bonds on Oct. 20

  • Bachoco files to establish 10b-peso debt shelf

  • Volaris to sell 1.5b pesos in local bonds on Oct. 6

  • Toyota Financial Services Mexico to sell 2b pesos of bonds on Oct. 7

  • Fovissste to sell 10b pesos of local bonds on Oct. 1

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