Money-Minting Peso Trade Upended by Mexico’s Election Shock

(Bloomberg) -- For the last two years, the world’s fund managers had a recipe to mint money in Mexico. Borrow anywhere interest rates were low, pile into Mexican assets — and clean up as the peso marched higher and higher.

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Virtually overnight, it’s no longer such a sure thing.

The landslide victory by Claudia Sheinbaum in the presidential election on Sunday has rattled markets by promising to significantly strengthen the hand of the nation’s ruling leftist party in legislation. That’s increased the chances that Sheinbaum could push through measures that eluded President Andres Manuel Lopez Obrador, such as changing rules on the selection of supreme court judges and eliminating independent regulators.

“The days of unwavering Mexican peso appreciation are probably over,” said Hari Hariharan, chief investment officer at NWI Management in New York.

The Mexican peso has tumbled, losing 5% this week in the biggest two-day drop since 2020. The country’s stocks, meanwhile, rebounded after plunging more than 6% on Monday.

The selloff showed few signs of abating on Tuesday, with a gauge of one-month implied volatility in the peso jumping to the highest since October, contributing to the sudden increase of risk premiums on Mexican assets. That’s quite a reversal for a strategy — buying pesos on the back of a benign backdrop of fiscal stability combine with favorable growth outlook — that until last week was providing investors double-digits returns.

“It’s a potential game-changer,” said Eric Fine, a portfolio manager at Van Eck Associates in New York, who has been underweight on Mexico. “We’re not inclined to view this as a buying opportunity.”

Going Long

While the rout in the peso may ultimately prove temporary, it has provided a stark reminder of how political risks can quickly upend strategies in emerging-market investing.

Sheinbaum’s victory was largely expected, but the ruling coalition was seen just holding onto a slim majority in legislative races. Instead, her party and allies obtained two-thirds of the seats in the lower house and nearly two-thirds in the senate. With that make up, Congress could pass more of the radical economic and political reforms proposed by AMLO back in February.

Few Mexico investors heeded the warnings of the handful of strategists that saw it coming. Up to last week, asset managers kept piling onto the peso, with net-long contracts on the currency near the highest since 2022, according to data from the Commodities and Futures Trade Commission through May 28.

For many investors the US presidential race in November was seen as more likely to spark volatility in the currency than local elections. Strategists at a couple of firms, including JPMorgan Chase & Co. and Barclays, acknowledged that a strong showing for Sheinbaum’s Morena party was possible. But they too said the chances were too small to change their own bullish recommendations on the peso.

Barclays went as far as correctly predicting the magnitude of a post-vote sell off in the currency — expected to underperform some 3% to 4% — but only closed a February bet on declines in the euro against the peso a day after the vote.

Strategists Erick Martinez and Andrea Kiguel wrote in a Monday note that while they don’t expect a long-lasting effect on the peso, “the market could take time to digest the results, especially as positioning is heavy.”

Brad Bechtel, global head of FX at Jefferies in New York said referring to peso-Japanese yen pair the jump in volatility will likely force many to reduce positions sizes.

“I expect we’ll hear some calming words from the new administration in the days to come and that will calm the panic in the Mexico peso but given the size of the position in the market we may have more room to run here,” he said in a note Monday.

While Sheinbaum confirmed late on Monday that Finance Minister Rogelio Ramirez de la O will continue in the post during her government, she has been fairly mum on specific policies. Investors are still waiting on clues on whether she’ll strike a more market-friendly tack than Lopez Obrador, or if she will back a swath of constitutional reforms that are seen entrenching the power of his Morena party and increasing meddling in the economy.

Ramirez de la O held a call with investors on Tuesday to allay their concerns. The “very brief” meeting failed to address the market’s biggest worry, said Marco Oviedo, a strategist at XP Investimentos, who participated.

He said traders now are focusing on a key one-month period starting in September, when the new legislature takes over while AMLO remains in office — meaning some reforms could pass even before Sheinbaum takes office in October.

“The government has a very important mandate,” said Shamaila Khan, UBS Asset Management’s head of fixed income for emerging markets, who had been holding a cautious view on Mexico ahead of the vote. “They can use it to do positive and negative things.”

(Updates with market move and details on investor call starting in paragraph five,)

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