Local currency bonds: Mexican peso attains global status

Latin America has a long history of crises involving wrenching devaluations, hyperinflation, or both. No-one knows this better than Latin Americans themselves; they generally keep savings of any magnitude safely offshore in dollars. If you’re looking to buy a house in the region, chances are it will be priced in dollars; if you’re a bank looking to attract local-currency deposits, you’ll have to pay a large premium over local dollar interest rates.

Even as the price of credit risk has declined dramatically over the past few years, currency risk has remained relatively expensive.

But 2005 looks as if it will be the year when Latin America finally attained a global currency of its very own: the Mexican peso.

Replacements

Looked at from a historical perspective, the Mexican peso is not the kind of instrument one would like to invest in over the long term. Even its official currency code spells danger: the old peso, or MXP, was replaced in 1993 with the new peso, or MXN. One new peso bought 1,000 old ones: a telling signal of Mexico’s woes since its default in 1982.

But this summer the Mexican peso joined the likes of the South African rand and the New Zealand dollar as a reasonably stable currency that a wide range of investors can look to for yield pick-up.

Large institutional investors have been buying domestic Mexican debt for years, of course, but they all have the ability to hedge their currency exposure as and when necessary. This summer, a new type of Mexican peso issuer emerged: highly rated European financial institutions selling bonds with maturities as long as 10 years to buy-and-hold investors.

The first deal was from Rabobank in March – this came with a Ps500 million ($45.2 million) five-year bond yielding 9.8%. The market really took off in May, however, when five deals totalling more than Ps2.3 billion were done.

The issuers were German development bank KfW, which came at three-year and five-year maturities, alongside UBS and Depfa, which both issued 10-year bonds with double-digit coupons.

Since then, the list of issuers has continued to increase, although all of them have been either triple-A or double-A rated. The European Investment Bank has done the most ambitious deal yet: a 10-year zero-coupon bond priced at 41.3 to yield just 9.2%. Total issuance is now more than Ps10 billion (or just below $1 billion) and shows no sign of slowing down.

The Mexican peso has essentially stepped in to replace such currencies as the Hungarian forint and Polish zloty, which were once high yielding but aren’t any more. Its strong links to the US dollar also make it attractive to investors that think the greenback has bottomed out.

Great yield

The investor base is truly international:

not only European retail but also smaller institutions, and also retail investors in Asia and even Canada. So far, there’s been no demand for lower-rated issues: the yield pick-up from the currency risk is so great that there’s no need for credit risk as well.

The issuers, for their part, immediately swap the proceeds back into dollars – Elijah Tyshynski, a trader at RBC Capital Markets in London, says that roughly half of the deals that have been done are swap-driven, with the other half responding to investor enquiries.

Tyshynski is also convinced that now the Mexican peso market has been opened it is here to stay. “Mexico’s long-term view is that rates are set to come down,” he says. “But even if they come down to 150 basis points to 200bp over the US, you’ll still find interest in this market.”