03 Juli 2018, 11:08 GMT
The political winds of change swept across Mexico last night as Andrés Manuel López Obrador (better known by the acronym AMLO) easily won Mexico’s Presidential election.
AMLO recorded around 53 per cent of the vote, well ahead of the other candidates, with the former mayor of Mexico City breaking the country’s long-standing PRI/PAN (Institutional Revolutionary Party/National Action Party) duopoly. Early results also suggest his MORENA (National Regeneration Movement), party look set to take simple majorities in both houses in Congress which will afford the populist leader a strong mandate. While his victory was anticipated by the polls and the markets, the historical significance of this moment cannot be ignored with Mexico electing its first left-wing President since the 1980s.
Crucially, the vote went smoothly with no sign of dispute from AMLO’s rivals following a divisive election campaign marred by extreme violence and the death of over 130 candidates and political staff. AMLO’s campaign tapped into wide spread anti-establishment anger amongst the Mexican population who have become disillusioned with years of corruption scandals amongst the political elite, spiralling nationwide violence, growing poverty and sluggish economic growth.
AMLO’s fiscal agenda has rattled investors over the past year with his populist policies set to boost social program benefits, increase pensions, expand infrastructure spending, roll back energy sector reform and halt the construction of Mexico City’s new airport. AMLO’s intentions are to fund this increased spending by reducing corruption amongst the political class and cutting the salaries of top government bureaucrats, but the bond markets have so far been unconvinced.
In our view, AMLO's pro-growth agenda will ultimately be more benign and investor friendly than the market’s worst fears. Early conciliatory comments following his victory hint at policy pragmatism, fiscal responsibility and national unity, while also promising not to reform Central Bank independence or give up on NAFTA. With most of the political uncertainty now removed, and the result largely as anticipated, we expect some short-term relief in Mexican markets as pre-election hedges get unwound, ex-ante volatility drops and the market focuses on the path towards his inauguration on 1 December.
We think the best value in Mexican markets is in local currency bonds. Banxico, the Mexican Central Bank, has done a stellar job in managing inflation expectations over the past 18 months given that the peso has depreciated 10 per cent against the US Dollar since Trump’s US election victory in November 2016. Domestic interest rates in Mexico have been hiked by 475 bps over that period, boosting Banxico’s policy credibility amongst investors to sky-high levels.
With domestic inflation likely to continue falling over the medium term, the real ex-ante policy rate in Mexico is now one of the tightest in the world and local bond valuations currently look attractive. As growth is consistently running below its potential rate, and CPI is trending back towards it’s medium term target, we think there is a higher than consensus chance for interest rate cuts in Mexico over the next 12 months.
While this part of the emerging market (EM) universe offers excessive risk premium, the exogenous backdrop is likely to remain very challenging over the coming months. EM is facing several awkward headwinds including a strengthening US dollar, tightening global liquidity, rising US funding costs, growing inflationary pressures, cooling global growth momentum and trade protectionism.
With that in mind, our optimism for Mexican local currency bonds is on a relative value basis versus the rest of EM, rather than in absolute terms.
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