The World’s No. 1 Carry Trade Is Fueled by AMLO’s Peso Obsession

Justin Villamil
1 / 3

The World’s No. 1 Carry Trade Is Fueled by AMLO’s Peso Obsession

(Bloomberg) -- In many ways, Mexican President Andres Manuel Lopez Obrador has been just about as toxic for investors as his detractors warned he would be. Stocks have badly underperformed during his 14-month tenure, the state-owned oil company had its credit rating cut to junk and economic growth is stagnant at best.

But there’s one corner of the market where the leftist leader has proven to be a staunch ally of investors, handing them a windfall that few anticipated: the carry trade. Investors following the typical strategy of borrowing cheaply in dollars and then plowing the proceeds into short-term peso notes have notched returns of 16% since the president’s inauguration in December 2018, far and away the best performance among major currencies. (The Canadian dollar is No. 2, with a mere 1% return in that span.) Lured by both the stability of the peso and Mexico’s high interest rates, investors keep piling in to the trade. Bullish positions on the peso are now near a record.

The genesis for much of this appears to be Lopez Obrador’s obsession with the currency. It’s become his real-time tool to gauge the state of the economy and investors’ perception of his administration, not unlike the way U.S. President Donald Trump fixates on the Dow Jones Industrial Average. Early every morning, Lopez Obrador checks the latest market snapshot, and then, if he detects any significant price action, will point it out in glowing terms to the broad national audience that tunes into his daily news conference. The peso is up 8.4% since he took office, a rally driven in part by the surprisingly conservative budget bills he’s submitted to congress the past two years.

To investors, a president so wrapped up in the day-to-day fluctuations of the peso is one that is unlikely to allow a rout.

“The administration has been very market conscious,” said Danny Fang, a strategist at BBVA in New York who says that the low volatility Lopez Obrador fostered has helped the carry trade. “When the U.S. threatened tariffs over immigration, which shook the Mexican peso, the AMLO government responded almost immediately. When market volatility increased, we often heard officials address it.”

The president, of course, isn’t alone in influencing the scope of carry-trade returns. The central bank’s decision to take a very gradual approach to cutting the benchmark rate -- it’s down to 7.25% from 8.25% shortly after he came to office -- is arguably the most important factor. But even there, Lopez Obrador has played a key role, opting not to meddle, as some feared he would, and to largely stay out of the central bank’s way as it moved hesitantly to cut rates and boost the economy.

The peso’s three-month volatility is near the lowest level since 2014 and the currency has strengthened 8.5% since Lopez Obrador took office, ranking it tops among emerging-market peers in that span. Some of the gain is simply a reversal of the heavy losses seen in the leadup to the inauguration, when investors fretted that the left-wing populist firebrand would upend Latin America’s second-biggest economy.

While some of the concerns proved well founded -- Lopez Obrador shocked investors by canceling an airport project in Mexico City, capital investment has fallen for nine straight months and in 2019 the economy created the fewest jobs since the global recession -- the widespread disaster that some predicted hasn’t materialized. In fact, Mexico has proven to be a beacon of stability in a region beset by political turmoil in Chile, Peru, Argentina and Brazil.

For many, the stability undergirding the carry trade is surprising, and of course risks still abound. While oil company Pemex has shown early signs of steadying production declines and investors eagerly snapped up its latest debt offering, the company is struggling with over $100 billion in debt and may yet be hit by a downgrade and subsequent forced bond sell-off. Economic expansion has been sluggish under Lopez Obrador, and the central bank is expected to continue cutting rates amid slow inflation and low growth. Bank of America expects a pickup in volatility in the second half.

Edwin Gutierrez, a London-based portfolio manager at Aberdeen Asset Management, says that the popularity of the carry trade makes it dangerous over the longer term. There’s a risk that investors could get spooked and rush to leave all at once, resulting in a sudden rout in Mexican assets.

“Positioning has been heavy for a while,” he said. “That’s the biggest risk to the trade.”

So far, it seems like most investors aren’t too concerned. Bullish peso positions are hovering near a record high, according to data published by the CFTC. Foreign purchases of peso-denominated assets have picked up recently, with overseas holdings of local notes climbing to a five-month high last month, according to data from the central bank.

One-month implied volatility -- expectations of future price swings -- plunged in the fourth quarter as Mexico, Canada and the U.S. approved a final version of the USMCA trade deal. Fears about a possible downgrade for state oil company Petroleos Mexicanos -- better known as Pemex -- have also faded.

At least in the short term, carry-trade bulls are in control. The peso will depreciate just a little over 2% by the end of the year, according to the median forecast of analysts surveyed by Bloomberg. And the most recent comments from central bank officials suggests there’s no rush to accelerate the pace of interest-rate cuts.

“The Mexican peso stands out as a currency that offers very high carry for reasonably low volatility,” said Carlos Carranza, an analyst at JPMorgan Chase & Co. who was the top forecaster for Latin American currencies in the fourth quarter. “Mexico offers value.”

--With assistance from Sydney Maki.

To contact the reporter on this story: Justin Villamil in Mexico City at jvillamil18@bloomberg.net

To contact the editors responsible for this story: Carolina Wilson at cwilson166@bloomberg.net, ;David Papadopoulos at papadopoulos@bloomberg.net, Brendan Walsh

For more articles like this, please visit us at bloomberg.com

Subscribe now to stay ahead with the most trusted business news source.

©2020 Bloomberg L.P.