If Mexico’s drug war continues to rage and if the economy continues to slow as it is in pockets, the odds for a populist leader taking the helm in this summer’s presidential election are quite good. Andres Manuel Lopez Obrador, better known as Amlo, is expected to win. The next president of Mexico faces a slight downturn in the economy as much of the world is in growth-mode, giving Amlo more fire power as the campaign heats up.
Mexico’s economy is surely not in reversal, though it is not growing as fast as it once was. That usually does not favor the incumbent party. With Mexico, the ruling Institutional Revolutionary Party (PRI) of Enrique Pena Nieto doesn’t stand a chance anyway. Amlo’s biggest attack will be on the establishment parties on matters of corruption and in dealing with a belligerent Trump presidency. The job market in Mexico is still solid, and all of this happened on PRI’s watch. Unemployment is as low in Mexico as it is here. This matters little because the PRI is not a serious contender.
“There is considerable uncertainty regarding the outlook for Mexico, with upcoming presidential elections and the unpredictable outcome of NAFTA negotiations,” says Humberto Garcia, head of global asset allocation for Bank Leumi USA.
After growing 2% in 2017, Mexico’s GDP has little upside. Consensus estimates are still for 2.2% growth, so Mexico is still going in the right direction.
Mexican manufacturing output grew 3.7% in year-over-year terms in August 2017, but has lost momentum since. Weak downstream demand from Mexican industry, a pullback in auto sales in the U.S. and Canada, and uncertainty about NAFTA are all major headwinds for Mexican manufacturers.
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“Mexico’s weak industrial activity reinforces our expectation that the Bank of Mexico’s next move is likely an interest rate cut,” says Bill Adams, senior international economist for PNC Financial. Rate cuts are good news for equity investors. The iShares MSCI Mexico (EWW) fund has been outperforming the MSCI Emerging Markets (EEM) exchange traded fund all year.
Mexican industrial production was unchanged on the month in January after a 1% increase in December. Industrial production fell 0.3% from January 2017. Investors won’t find that panic-inducing.
But from a year earlier, mining production fell 5.1% and that includes a 5.4% drop in oil and gas.
Banxico’s recent commentary noted weaker economic activity and weaker inflation, all pointing to market-friendly rate cuts.
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Mexico’s economic data argues for a neutral monetary policy rate, roughly equal to Mexico’s expected nominal GDP growth rate of somewhere between 5% to 6%.
Barring worst case scenarios in NAFTA trade talks, PNC’s senior economist thinks Mexico’s central bank cuts interest rates from 7.5% currently to 7% by year-end 2018 and 6% by year-end 2019, a potential bull signal for Mexican local currency debt. As rates go down, those holding higher yielding bonds will see their bond values rise.
On the other hand, if Amlo wins, the Bank of Mexico would likely be forced to keep interest rates high to support the value of the peso, keeping Mexico’s economy in slow-mo, Adams believes.
Anti-Trump Amlo is not a shoo-in, however. Moreover, if he wins, he would not have anything close to a mandate and would have to form a coalition with stronger parties. In other words, the market does not believe Amlo is the next Hugo Chavez. Amlo might make for negative headlines regarding NAFTA as he has come out against the trade deal for years.
“The country has achieved a remarkably low official unemployment rate and a quick look at GDP data shows strength in machinery and equipment manufacturing, retail, transportation and finance,” says Garcia, noting all the data points that might make Mexican voters stick with the status quo. Corruption charges against PRI could be their undoing, with the market friendly National Action Party (PAN) candidate Ricardo Anaya singing the same tune as Amlo in this regard. Anaya trails Amlo.
Mexicans go to the polls on July 1.
“If Lopez Obrador makes it, markets will take it badly,” says Fernando Pertini, chief financial advisor of Millenia Asset Management in Costa Rica.
Amlo has promised Mexico’s version of Brazil’s Operation Car Wash, a deep corruption probe which knocked out establishment politicians and rattled the economy. Brazil is only now coming out of back-to-back years of economic contraction.
“The biggest difference between Brazil’s corruption crackdown and Mexico’s is if Amlo wins, he vows more social spending,” Pertini says, saying he is neutral on Mexico, but is more constructive than he was a few months ago. “I’m neutral on Mexico with or without Amlo,” he says.