Bloomberg News

October Rate-Cut Bet Shows U.S. Slump Spreading: Mexico Credit

September 06, 2011

Sept. 6 (Bloomberg) -- Mexico will follow Brazil and Turkey in cutting interest rates next month to help shield the economy from a slowdown in the U.S., swaps trading shows.

Yields on futures contracts for October, known as TIIE, sank nine basis points in the past month to 4.73 percent, indicating traders expect central bank Governor Agustin Carstens to lower the benchmark 4.5 percent rate when the board meets Oct. 14. Those wagers signal a reversal for traders who expected as recently as Aug. 25 that Carstens’s next move would be to raise borrowing costs from a record low.

Concern the U.S. and Europe may be headed for recessions is prompting investors to anticipate developing countries will lower rates to shore up growth. Mexico’s central bank, the only among major Latin American countries to hold off on raising rates as the global economy recovered from the 2008 financial crisis, said Aug. 26 it would consider “adjusting” policy if the growth outlook worsened. Employment unexpectedly stagnated in the U.S., Mexico’s biggest trade partner, last month.

“Banco de Mexico was very clear in its previous statement that it would adapt to new circumstances,” said Alberto Bernal, head of fixed-income research for Bulltick Capital Markets, in a telephone interview from Bogota. “The bad news on the jobs front increases that probability.”

In Brazil, traders are betting policy makers will reduce their rate further after last week’s surprise 50-basis point cut to 12 percent, while Chilean swaps are also pricing in the possibility of a cut this year.

U.S. Contraction

The yield on Mexico’s benchmark bonds due in 2024 fell to a one-week low on Sept. 2, when the U.S. reported no job growth in the world’s biggest economy. Yields on the securities have tumbled 56 basis points, or 0.56 percentage point, since the end of July to 6.23 percent, according to data compiled by Bloomberg.

September could mark the start of a slump in the U.S., the destination for 80 percent of Mexican exports, said Julia Coronado, chief economist for North America at BNP Paribas in New York. She predicts the U.S. economy will shrink at a 2 percent annual rate in the fourth quarter. Economists at UniCredit Group and Mesirow Financial Inc. also say the U.S. is at risk of tipping into recession two years after the last one ended in June 2009.

The European Central Bank will probably cut interest rates as the chance of a recession in the euro zone has risen to 50 percent, Mohamed El-Erian, who manages the world’s largest bond fund as the chief executive officer of Pacific Investment Management Co., said last week.

Mexico Outlook

Brazilian central bankers said in a statement following their Aug. 31 rate decision that a “substantial deterioration” in the global economy may be “prolonged,” slowing trade, investment and credit flows to Latin America’s biggest economy.

Citigroup Inc. cut its 2011 global economic growth forecast yesterday to 3.1 percent from 3.7 percent.

Mexico economists lowered their 2011 growth estimates for the third time this year, according to a central bank survey published Sept. 1. They predict gross domestic product will expand 3.81 percent, down from a July forecast of 4.24 percent. Latin America’s second-biggest economy grew 5.4 percent last year, the fastest pace in a decade.

Slowing growth and tame inflation may lead Banxico, as Mexico’s central bank is known, to reduce the benchmark rate, said Javier Belaunzaran, who helps manage about 40 billion pesos at Interacciones Casa de Bolsa SA in Mexico City.

Breakeven Rate

The annual inflation rate declined to 3.49 percent in August from 3.55 percent last month, according to the median estimate of 10 economists in a Bloomberg survey. The government will publish the report on Sept. 8.

Inflation has hovered near the central bank’s 3 percent target since reaching a five-year low of 3.04 percent in March.

“The economic situation has deteriorated a lot,” Belaunzaran said in a telephone interview. “Inflation data is staying well, well below expectations. The probability is growing that they’ll” cut rates, he said.

The yield gap between inflation-linked debt due in 2013 and similar-maturity fixed-rate bonds, a gauge of investor expectations for consumer price increases, sank 56 basis points in the past month to 369 yesterday, the lowest since June, according to data compiled by Bloomberg.

A press official from the central bank didn’t return phone messages and an e-mail seeking comment.

The extra yield investors demand to own Mexican government dollar bonds instead of U.S. Treasuries widened one basis point to 216 at 7:38 p.m. New York time, according to JPMorgan’s EMBI Global index.

No ‘Imminent Risk’

The cost to protect Mexican debt against non-payment for five years rose seven basis points to 160, according to data provider CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market. Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent if a government or company fails to adhere to its debt agreements.

The peso rose 0.2 percent to 12.5119 per U.S. dollar.

A rate cut next month would be premature and is unlikely from a central bank that tends to move “slowly,” said Eduardo Avila, an economist with Monex Casa de Bolsa SA in Mexico City.

“Banxico tends to work more slowly,” Avila said. “They don’t announce something and then in the next meeting take action. There isn’t a sense of imminent risk that justifies lowering rates.”

Avila forecasts the economy will grow 4 percent this year while inflation will end the year at 3.2 percent.

After scrapping predications for a rate increase on Aug. 26, traders forecast the reduction would come by November. They moved up those wagers as U.S. recession concerns mounted and after Brazil lowered rates.

“It’s a possibility that they will act” as soon as October, Bulltick’s Bernal said. “The U.S. economy is just not performing as it should. It’s too early for us to see job creation plateau. It’s really worrisome.”

--Editors: Lester Pimentel, Jonathan Roeder

To contact the reporters on this story: Jonathan J. Levin in Mexico City at jlevin20@bloomberg.net

To contact the editor responsible for this story: David Papadopoulos at papadopoulos@bloomberg.net


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