Mexico Peso Falls as Ruling Party Landslide Spooks Investors

Michael O'Boyle and Vinícius Andrade
Mon, Jun 3, 2024, 

(Bloomberg) -- Mexican assets tumbled after preliminary election results showed the ruling party winning in a landslide that may empower it to increase state control of the economy and undermine checks on its power

The peso led global losses, sinking as much as 4% before trimming its decline, while swap rates climbed and stocks slumped on Monday. Official projections showed Claudia Sheinbaum, the protege of President Andres Manuel Lopez Obrador, winning by at least 30 percentage points.

While her win was largely priced in, the quick count published by the electoral authority also pointed to the ruling Morena party and its allies winning a so-called supermajority in the lower house and clinching at least a simple majority in the Senate — more support than polls suggested. Investors were closely eyeing the congressional races as a two-thirds majority would give the ruling coalition a mandate to pass more ambitious reforms that could change the constitution.

“The potential for a supermajority does cause some concern as it could erode Mexico’s fiscal prudence seen during most of AMLO’s administration,” said Guido Chamorro, senior portfolio manager at Pictet Asset Management in London, referring to Lopez Obrador. “There is a question about how fiscally conservative Sheinbaum will be.”

Reforms

The congressional results will determine if Morena will be in the position to pass a swath of proposals made by Lopez Obrador in February. Those bills include plans to reduce the number of lawmakers and allow for the direct election of Supreme Court justices. They also include eliminating independent regulators, like the antitrust commission, as well as establishing new pension obligations and mandatory minimum wage hikes.

Such an outcome could sap appetite for Mexico assets, including the peso, which has been one of the top performing major currencies this year against the dollar. The peso has defied calls that it’s overvalued and continued to rise, with Mexico’s close ties with the US shielding the currency from the strong dollar that has roiled other developing nations. It’s also been supported by a hawkish central bank that has been the slowest in Latin America to lower borrowing costs.

The iShares MSCI Mexico ETF (EWW), the biggest US exchange traded fund tracking Mexican equities, fell as much as 7.9% Monday, the most intraday since June 2020. EWW has seen over 890,000 shares traded as of 10:05 a.m. in New York, close to five times the 20-day average for this time of day, data compiled by Bloomberg show. Dollar bonds were little changed after edging lower earlier in the day.

If the next government and Congress adopt an unorthodox agenda that undermines Mexican institutions, the peso would weaken to 19.20 per US dollar, Morgan Stanley analysts said in an April note. Barclays strategists saw odds the peso would see a 4% plunge if Morena were to win a constitutional majority that would lead to a more leftist radical reform agenda, they wrote in a note ahead of the election, while adding that chances of that were small.

“The possibility of a supermajority in congress would be a material game changer for Mexico,” said Gordian Kemen, head of emerging-market sovereign strategy at Standard Chartered Bank. “I can see the market getting concerned about energy policy, fiscal stance, but also monetary policy.”

‘Super peso’

The peso has also been the best performing major currency over the last six years, during Lopez Obrador’s term, flying in the face of concerns that his policies would spark a deep devaluation. His government bucked expectations for higher spending and instead maintained fiscal discipline that set it apart from other economies, whose deficits blew out during the pandemic. However, Lopez Obrador ramped up spending this year, leaving the challenge to Sheinbaum to rein it back in.

Sheinbaum’s double-digit lead in the months ahead of the election had helped keep the peso steady on an expectation of continuity. Investors have seen Sheinbaum providing stability in Latin America’s second-largest economy with the potential that she takes a more market-friendly tack than Lopez Obrador, who couldn’t seek another term.

Analysts at Morgan Stanley projected there was a chance that Sheinbaum could be more open to private investment in the power sector and take measures to draw more factories to Mexico in the trend called nearshoring.

In her first speech as president-elect, Sheinbaum pledged to respect central bank autonomy and fiscal discipline, calling for more investment in renewable energy and promising to promote foreign investment.

The strong carry appeal for the currency should continue to provide some support for the Mexican peso, potentially making any selloffs transitory, said Claudia Ceja, a strategist at BBVA Mexico.

Mexico’s long transition period — the new Congress won’t take office until September, while Sheinbaum will be inaugurated in October — also means it will take some time to see if investors’ initial concerns play out.

That also leaves space for Congress to approve some of Lopez Obrador’s proposed reforms before Sheinbaum’s first day in office, said Gabriel Casillas, chief Latin America economist at Barclays.

“This is not what market participants were expecting,” Casillas said. “We could see a further adjustment of asset prices to reflect this apparent new reality.”

--With assistance from Selcuk Gokoluk, Maria Elena Vizcaino, Carolina Wilson, Matthew Burgess and Colleen Goko.

(Updates with market prices and comments starting in second paragraph.)