Latin America: Mexico to bear the brunt of Trump
Regional FX volatility and capital outflows likely to hit LatAm; biggest risk comes from protectionism policies in the medium term.
Donald Trump and Mexico's president Enrique Peña Nieto meet in August
The news of Donald Trump’s victory in the 2016 US election has focused investors’ attention on the implications for Mexico.
However, there many other regional implications – particularly for the economies of central America – that will play out over the coming days, weeks and months.
Mexico naturally is the focus: today the US and its southern neighbour conduct annual bilateral trade of $500 billion in goods alone, equivalent to 45% of Mexico’s GDP.
Since its inception in 1994, the North American Free Trade Agreement – a renegotiation of which was arguably Trump’s leading electoral pledge – has led bilateral trade to grow five-fold.
Mexico enjoys a significant trade surplus, but the relationship is far from one-way. Growing energy imports from the US mean that today 14.9% of US exports go to Mexico and 13.8% of imports come from Mexico – making the country its third largest export market, behind China and Canada.
Mexico runs a $73 billion trade surplus with the US, but this is due to only one industry: autos. If that industry is discounted, Mexico is running a trade deficit – and one that is widening due to the rising energy impacts.
Nonetheless, the Mexican economy is significantly exposed to a Trump administration.
US protectionism is a negative for EM FX and could lead to ‘beggar thy neighbour’ competitive devaluations and trade wars from counter-measures from other countries - Exotix
BNP Paribas isn’t alone in now forecasting that the Mexican central bank will respond with up to 100 basis points of interest-rate increases over the bank’s last two monetary policy meetings of 2016. The curve is currently pricing in 40% probability of 50bp increases at both the November and December policy meetings.
“It is plausible that the monetary authority would be forced to deliver 100bp as another attempt to preserve financial stability in Mexico [not necessarily sticking to any peso level],” states the BNP report.
Its lead author Gabriel Gersztein adds: “We believe the first line of defence for the foreign exchange commission, comprised of Banxico and finance ministry members, would be to conduct extraordinary USD sales with the aim of guaranteeing the currency’s functionality and liquidity.”
The Mexican central bank has FX reserves of $175.3 billion – lower than at the start of 2016 and perhaps not at a level that the market will see as sufficient to defend the currency if the rout continues.
The peso – a fully convertible currency and traded 24 hours – has been the proxy trade for Trump’s fortunes throughout the election campaign.
Capital Economics says the floor could be MXN25 to the dollar, which, if reached and sustained, would lead to significant pass-through inflationary pressures that would add to the likelihood of interest rates.
The openness of the country’s financial system now also presents potential weakness during this systemic shock: more than 60% of the government’s local Mbono bonds are held by international investors and if there is a substantial sell-off it could lead to systemic financial instability.
“Different from Japan or even Brazil, the high level of dollarization and foreign participation in the bond market gives the authorities fewer degrees of freedom,” according to BNP’s Gersztein.
“While inflation expectations remained anchored, the leeway for a weaker MXN is not boundless. At some point, a disruptive currency would start affecting the attractiveness of the local bond market.”
International capital flows are likely to slow or reverse more generally in the region after a strong 12 months driven by investors’ search for yield. However, the increase in risk aversion will likely dominate – at least in the short term.
This will have “a negative impact on bond [external debt and local currency] currency and equity valuations in emerging and frontier markets,” according to Stuart Culverhouse, head of research at Exotix.
He expects that emerging market (EM) nominal yields will rise as EM country risk widens on economic, trade and foreign-policy uncertainty, which will expose those countries with already weak fundamentals, low reserves and high financing needs.
The financial impacts will be largely negative in the short term, but severity and duration of the impact will be determined by the still-uncertain policies implemented by president Trump.
However, increased protectionism looks the likely outcome and those countries with stronger trade and economic links with the US – such as the Dominican Republic and El Salvador in central America – look particularly vulnerable.
The Trans-Pacific Partnership is almost certainly dead and those economies in Latin America and Asia that would have benefited from those improved trade flows will be negatively impacted.
“US protectionism is a negative for EM FX and could lead to ‘beggar thy neighbour’ competitive devaluations and trade wars from counter-measures from other countries,” says a report by Exotix.
“Another area of concern for EM/ frontiers under a Trump win is it will put greater long-term pressures on immigration to / remittance growth from US [Nigeria, central America and the Caribbean].”
That remittance issue will also negatively impact Mexico.
BNP notes: “The Mexican balance of payments relies heavily on its northern neighbour, due to its record trade-balance surplus with the US and remittances from abroad.
“A more protectionist stance from the US would not bode well for growth and would have negative impact on the fiscal front and the structural current account. Under such a scenario, we think Mexico’s credit will be downgraded.”
The negative impact of the US presidential elections will be felt throughout the EMs and Latin America, but whichever way you cut it, it is Mexico that is and will feel the full brunt of Trump.