Rising Inflation, Falling Peso Dominate Outlook
Lower growth and the potential of a renegotiation of the North American Free Trade Agreement (NAFTA) occurring this year, among other risk factors, are creating what some market analysts are now referring to as the ‘perfect storm’ for Mexico’s economy. With the central bank (Banixco) aware of what may lie ahead, monetary and fiscal policies began to tighten before the rise of Donald Trump to the White House.
Now, with near-daily rhetoric and threats to NAFTA, one of the US’s biggest trading partners and neighboring ally is facing a mix of domestic and international headwinds that are both depressing consumption across the country and impacting investment.
Data shows that 2016 growth in Mexico eased to 2.2 percent from 2.5 percent in 2015. “Amid policy tightening and Trump-related uncertainty, growth is likely to slide to around 1% this year,” Lawrence Brainard, chief economist with London-based Lombard Street Research wrote in a note to clients on February 17th.
Headline inflation, which spiked to 4.7 percent in January will probably touch 6% before ending the year around 5.5%, Lombard Street notes. The sharp rise was largely due to the lagged effects of the depreciation of the peso that slid 20% between September 2016 and its low point in January of this year.
NAFTA Negotiations Likely Under Trump
There remains an obvious dominance of complicated global value chains that exist within the US-Mexican trade. Most notably in autos and its respective and parts.
Also not to be overlooked is the “critical importance” of Mexico to US farm states that voted 2 to 1 for Trump (agricultural exports to Mexico are worth $18 billion, third-largest US foreign destination). This suggests the new US administration will focus its attention on updating aspects of NAFTA rather than impose a border tax that would ultimately trigger Mexican retaliation, which in turn could trigger a shift of the country’s grain imports to Brazil and Argentina.
“More significantly,” says Brainard, is the evident policy turmoil within the White House that has emboldened Republicans in Congress to dig in their heels to assert their influence vis-à-vis a White House they view as a major liability to the interests of their constituents and their own re-election chances.”
Even with the current downbeat economic outlook, a successful renegotiation of NAFTA later this year would be positive for Mexican markets and the peso. Current valuations have incorporated negative outcomes in the US-Mexican trade that will probably not materialize. “Fears of a left-wing populist victory in the July 2018 election, though, will begin rising later this year and could erode any rally,” Brainard said.
Domestic Political Challenges On The Horizon
Andrés Manuel López Obrador (AMLO), a popular and left-wing firebrand is currently leading in early polls for Mexico’s July 2018 presidential election. AMLO is very much in the “Trump mold”, explains Brainard. “Populist, anti-establishment and skilled at rhetoric promising an overthrow of the status quo.”
President’s Trump’s consistent rhetoric and behavior toward Mexico has inadvertently given AMLO an opening to denounce “chauvinist demagoguery” and disregard for human rights. Similar to Trump, AMLO will likely continue with his populist appeal to the masses while at the same time pandering to business interests. For example, by calling for greater trade protection. Having lost two previous presidential runs, AMLO now appears to be trying to imitate the path of former Brazilian President Lula, who came back from earlier defeats to win Brazil’s 2002 election.
“Political risks also stand to undermine confidence in Mexico.”
This is the second in our series concerning emerging markets under the new US Administration.
Photo Credit: Henry Romero/Reuters