Food for thought on the strength of the peso...

Foreign investment in peso-denominated money market obligations jumped US$12.23 billion in the first nine months of this year. Those volatile capital inflows were the equivalent of ¾ of remittances in the same period, 85% of direct foreign investment, and 55% of crude oil export revenues. Portfolio investment can leave as easily as it comes into a country. If the European authorities do not succeed in containing the Europe-centered financial crisis and there were to be a resurgence of risk aversion on the scale of the six months between October 2008 and March 2009…

Where the elderly in the US get their income...

The numbers speak for themselves... (Source: http://krugman.blogs.nytimes.com/?nl=todaysheadlines&emc=a212)

Portfolio investment inflows welcomed in Mexico

The interest rate premium (between peso and dollar investments) creates an attractive “carry trade” opportunity, especially when coupled with a stable or appreciating exchange rate. Investors who can borrow in dollars or other currencies where interest rates are low can invest in higher yielding peso instruments, reaping the interest rate differential and generating handsome profits. Obviously, if the peso devalues, profits can disappear. The Fed's QE2 (the second round of quantitative easing) adds fuel to the carry trade fire.

Mexico is only one of many countries in which investors are playing the carry trade game. The peso has appreciated less than the exchange rates of some other “emerging countries”, whose governments are quite concerned about the impact of a strengthening currency on trade flows and the creation of stock and property bubbles.

Governments ranging from Chile and Brazil to Thailand and Malaysia have imposed measures ranging from taxes to limits on investments in short-term money market instruments to try to dampen the negative effects of an appreciating exchange rate based on portfolio investment flows. Mexico has not.

Mexico’s policy was summed up by Banxico Deputy Governor Manuel Sanchez in a November 18, 2010 speech delivered at a Cato Institute symposium: “…capital controls may lessen investor confidence in these economies [countries that impose capital inflows], generate black markets, and inhibit the entry of capital necessary for innovation and productivity improvements. Currency interventions, in turn, are hardly effective and tend to impose financial losses on the central bank. Furthermore, the most important threat generated by these actions is a widespread movement toward protectionism that could hamper the sustained recovery of the world economy. Thus, it is preferable to completely avoid these measures.”

Glass half empty or glass half full?

Mexico's GDP grew 5.3% (year over year) in the third quarter, well below the second quarter's 7.6% rate but above expectations. The second quarter rate benefitted from the "base effect": the economy was in such bad shape in the second quarter of 2009 (-9.6% versus the second quarter of 2008) that the year over year comparison looked good with any growth. In the third quarter of last year, GDP contracted "only" 5.5%. So, is the glass half empty or half full? It looks fuller to me.

If, as seems quite feasible, GDP grows 3.0% year over year in the fourth quarter, the growth rate for the year will be 5.1%. The flip side of this year's good news is that next year's growth rate will be lower -- we'll be measuring it against a higher base.

What comes in can go out...

Today's jump in the fix rate put the peso at its highest level of the last 17 trading days. It's no coincidence that the cost of a dollar climbed $0.18 between last Friday and today, the first working day of this week: the concern over Ireland is rocking world equity markets as well.

X-Box for planners!

Making the INEGI an autonomous entity has paid off big for those of us who use their information. Check out the nifty new "growth cycle" indicator (see the following link).

http://www.inegi.org.mx/sistemas/reloj_cicloseco/default.aspx

INEGI has also developed a tool that will be of great help in business planning. For those of you who are interested in seeing it, I'll invite someone from the INEGI to the December Economex meetings to demonstrate how it works.

Ireland: damned if you do and damned if you don't

In spite of being lauded for the rapidity with which it implemented draconian measures to deal with its banking crisis and government debt levels, Ireland once again finds that the premiums investors demand to buy its debt have climbed. Fortunately for the country, it has already funded its borrowing needs through the middle of next year so it can opt not to place debt at these rates.

Why do Ireland's problems matter to Mexico? For several reasons... First, if the Europe-centered financial crisis were to erupt again, the dollar would strengthen and the peso along with it. In the worst of cases, we could see financial markets freeze up again. Second, Ireland's position now is a vivid reminder that markets can be fickle: portfolio investment that comes in can go out in as long as it takes for someone to press the "enter" key. Being the markets' poster child -- slashing government spending, saving its banks, and sticking to its austerity program -- doesn't guarantee that the premium for issuing debt later won't soar.