Mexico's incoming leftist president Andres Manuel Lopez Obrador has spooked markets.
Investors may have again overshot when it comes to politics in Mexico and Brazil.
AMLO to Bond Market: Drop Dead
The announcement by Mexico President-elect Andres Manuel Lopez Obrador, known as AMLO, that he will be cancelling the planned construction of a new airport for Mexico City in the valley of Texcoco, was not what the markets wanted to hear. Much money has already been sunk into the airport project , which has issued bonds internationally to finance construction. In response, bond traders pushed yields on Mexico's government bonds to their highest this decade relative to U.S. Treasuries.
If we look at the yield on U.S. dollar-denominated Mexican debt, that has also risen sharply, to the highest since 2011:
Evidently, the market took this as a critical test of the fledgling administration. Sticking with the airport was seen as a sign of responsibility, continuity, commitment to growth and a willingness to follow through with commitments to international investors. It failed on all those points.
And yet some context is necessary. This move demonstrates both the potential upside and downside of AMLO as president. It also underscores the reasons behind Mexico's infuriating refusal to move its economy forward. Back in 2000, the right-of-center Vicente Fox was elected president, becoming the first politician to topple the hegemonic Institutional Revolutionary Party (PRI) that was in power for more than 70 years. Fox was greeted with great excitement and genuine goodwill in international markets, and proceeded to accomplish little or none of his promised agenda. This was, in part, because he made many poor strategic and tactical decisions, and mainly because of a well-entrenched opposition.
The pivotal moment when confidence was lost came in August 2002, when he cancelled the planned construction of a new airport for Mexico City in the valley of Texcoco. There is truly nothing new under the sun.
In Fox's case, he was forced to back down by angry peasants who stood to be displaced by the airport, took the local mayor hostage, and held him at machete-point. In AMLO's case, the decision to scrap Texcoco and instead build extra runways at a military airport near Tizayuca in the neighboring state of Hidalgo, which has been regarded as the main alternative to the Texcoco site for two decades, followed a referendum organized by AMLO's own party after he took power. It probably does not have any legally binding force.
The upside is that AMLO understands the priorities of Mexican voters, their deep distrust of the government and the governing class. The Texcoco site may be too close to the city, and there is a widespread belief that its construction has been too expensive and corrupt, with money going to friendly contractors. There are valid arguments to prefer Tizayuca — along with plenty to oppose it. As Fox discovered more than a decade ago, Mexico's very strong agrarian lobby dislikes any plan for a Texcoco airport. AMLO was mayor of Mexico City at the time, where he showed that he could pragmatic when he needed to be, and understands the local issues. Getting out of it now before he formally takes power could be a big symbolic gesture to his people that he is on their side — which then gives him more room to do some things that international investors like and locals dislike. This should not be taken as a deliberate middle finger to international capital even if it looks like it . (The headline of a column in El Universal, one of the most powerful Mexican newspapers, was “AMLO to markets: I'm in charge here.”) It also reflects recognition that the project is fraught with difficulties.
The downside is in what it shows us about the way AMLO might be preparing to operate. Mexico's constitution has a separation of powers very similar to that of the U.S., but the seven-decade rule of the Institutional Revolutionary Party left it without the institutions and customs that allowed things to get done. Congress has regularly blocked presidential initiatives since 2000. AMLO has a demagogic, or even messianic, side to him, and he also has a penchant for holding referendums. These could allow him to bypass Congress and go right to the people. While mayor, he held a referendum on abolishing daylight-savings on the grounds that he did not want Mexicans to change their clocks just to be in line with the New York Stock Exchange.
If he proposes to operate like that on the national stage, that would be alarming. One suggestion already doing the rounds is that he could hold a referendum on allowing himself to run for a second term. The constitution currently has very strict term limits.
So there are risks and opportunities here. But I would suggest it is best to look at Mexico in conjunction with Latin America's other powerhouse economy, Brazil. Both have markets with relatively small free floats, where foreign investors can have an outsized impact. As much money is invested through “Latin American” funds, or through emerging-market funds, there are many portfolio managers whose job is effectively to choose between the two. The result is extraordinary swings and overreactions, usually led by politics. This is how MSCI's Mexico index has performed relative to its Brazil index this century:
This chart does, incidentally, look a lot like the beautiful twin volcanoes on Mexico City's skyline . Meanwhile, if we look at the exchange rate between the Mexican peso and the Brazilian real, we see that this has been the worst month for the peso since early 2003 — when President Lula was freshly installed in Brazil and convincing investors that he was not a left-wing monster after all:
Generally, any emphatic market judgment on politics in one country is likely to be reversed within a year or two. Any judgment is also likely to have a wildly inflated impact on the price of assets in the two countries.
In Brazil, investors have convinced themselves that Jair Bolsonaro will be a market-friendly president , even though (unlike AMLO) he appears to have little interest in the economy, and set out his stall on a series of aggressive, if not brutal, measures to deal with Brazil's high crime rate. Unlike AMLO, he is unproven as a manager and has never tackled anything as difficult as running Mexico City.
As with AMLO, he will have an opportunity over the next few months to make a series of symbolic gestures. His choices of treasury minister and central bank governor are crucial, as is his choice of the first few measures he chooses to prioritize in his dealings with the legislature.
Political risk in both Brazil and Mexico remains high, even though we now know the identity of their presidents for the next few years. The market's current judgment could prove to be correct. But the balance of probability points to Mexico having a greater chance of revival from here than Brazil.
Made in China: Volatility returned to U.S. stocks again Monday afternoon. This is still, I think, largely about forced sellers as speculators such as hedge funds get used to the reality of having to operate with less leverage. But it would be wise to note that there is obviously a Chinese component to this. Since 2016, the more a company was exposed to China, the better it had done. But that has all changed in recent weeks, and those companies are doing worse.
Knives out for Powell. Headlines on the Bloomberg terminal the last few days make clear that traders are growing angry with the Federal Reserve, and blame the central bank and its chairman, Jerome Powell, for the sell-off. The market is sending a message that the Fed does not want to hear . Meanwhile traders are spooked and do not believe the Fed will follow through on its plan to raise interest rates as much as it projects.
This looks unwise to me, and also to Bloomberg Opinion columnist Brian Chappatta . There is a point where a drop in a stock market becomes so great as to create a macro-prudential issue, and justify intervention by the Fed. It is not clear where that point is, but the Fed does not appear to believe that it is anywhere close. This is a point also made by Morgan Stanley .
In brief, it is the Fed's job to take away the punch bowl just before the party gets too rowdy. Complaints from a bunch of teenagers that they want more punch may well help to convince central bankers to take away the punch bowl.
Green Fields of the Mind
This is a time for celebration, if you are of the Red Sox persuasion. Boston's Major League Baseball team just enjoyed the best season anyone has had this century, winning 108 games in the regular season and then winning the World Series title for the fourth time in 15 years. For those of us who like the Red Sox, it has been a glorious shared experience. As the fans of a former World Series champion, the Pittsburgh Pirates , used to sing: We Are Family .
Given the weekend's events in Pittsburgh, the idea that we are all family seems sadly far-fetched. But there remains something to the notion that sports can bring people together, rather than bring out the worst tribal impulses that were on display in Pittsburgh. And there is also something to the notion that sports offer us a sense of continuity and a rhythm and pattern to existence — one that is certainly far more comforting than the rhythms and patterns of the markets, but that helps to make life worth living.
This is an essay by the late Bart Giamatti, the former president of Yale University who gave up that job to become the commissioner of Major League Baseball. A literary scholar, he was also a hopeless Red Sox fan, who did not live to see their recent run of glory. His essay, “ The Green Fields of the Mind ,” was written after yet another crushing Red Sox loss to end a season, but it seems just as apposite at the end of a season of triumph, and it also seems just as apposite for those who somebody else completely. You can listen to him reading the essay out loud here , and you can here it set to music here . He ended his piece thus:
It breaks my heart because it was meant to, because it was meant to foster in me again the illusion that there was something abiding, some pattern and some impulse that could come together to make a reality that would resist the corrosion; and because, after it had fostered again that most hungered-for illusion, the game was meant to stop, and betray precisely what it promised.
Of course, there are those who learn after the first few times. They grow out of sports. And there are others who were born with the wisdom to know that nothing lasts. These are the truly tough among us, the ones who can live without illusion, or without even the hope of illusion. I am not that grown-up or up-to-date. I am a simpler creature, tied to more primitive patterns and cycles. I need to think something lasts forever, and it might as well be that state of being that is a game; it might as well be that, in a green field, in the sun.
John Authers is a senior editor for markets. Before Bloomberg, he spent 29 years with the Financial Times, where he was head of the Lex Column and chief markets commentator. He is the author of “The Fearful Rise of Markets” and other books. Petroleumworld does not necessarily share these views.
Editor's Note: This article was originally published by Bloomberg , Oct 29 , 2018. All comments posted and published on Petroleumworld, do not reflect either for or against the opinion expressed in the comment as an endorsement of Petroleumworld.
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