Mexico risks priced-in but caution is warranted

Mexican stocks are down by over 8% and the Mexican peso has depreciated by over 10% in 2024. Part of this has been attributed to risks associated with the June election result and potential impact from a deceleration in the US. In this Macro Flash Note, economist Joaquin Thul explains the risks to Mexico’s outlook for the coming months.

On 02 June, Claudia Sheinbaum became the first woman elected as President in Mexico. Her victory was expected, but her party’s supermajority in the lower house was not.¹ Although Sheinbaum’s coalition fell slightly short of a similar result in the Senate, analysts believe she will be able to negotiate with Senators to reach the required majorities to pass her proposed reforms.

Mexican stocks, measured by the IPC stock index, sold off by 6% on the day after the election as fears of a more radical reform agenda and potential lack of fiscal responsibility spooked investors. Additionally, the Mexican peso depreciated by over 5% against the US dollar, extending the currency sell-off to over 10% year-to-date (see Chart 1).

Investors fear that Sheinbaum will pass the potentially disruptive judicial reform she campaigned for. The proposal aims to elect every judge across the country by popular vote, which would make the judicial system more politicised and less independent. She also aims to enact changes to the electoral system, eliminate autonomous institutions and increase regulation in the energy and mining sectors.

Source: LSEG Data & Analytics and EFGAM. Data as of 2 September 2024. Past performance is not indicative of future results.

In an attempt to appease markets, Sheinbaum reappointed Rogelio Ramirez de la O as Finance Minister, who has been responsible for Mexico’s fiscal prudence since his appointment by President Lopez Obrador in 2021. Mexico’s primary balance has improved over the last few years, while interest debt payments have increased as a combination of higher interest rates and an increase in debt levels. The combined debt represented 44% of GDP as of the end of 2023 and is composed of government debt and liabilities from Pemex, the state-run oil company, and Mexico’s Federal Electricity Commission (CFE) (see Chart 2).

Source: LSEG Data & Analytics and EFGAM. Data as of 20 August 2024.

Sheinbaum also chose technically experienced officials in key areas such as the energy ministry, Pemex and CFE. They will oversee the transition into renewable energy sources in the coming years. Mexican firms will need to operate with 100% clean energy sources by 2030 if they want to continue attracting US investments as part of their nearshoring policies. Additionally, large investments in water infrastructure will be required, with potential for increase taxes on mining and energy sectors expected.

Impact from US elections

Aside from domestic factors, Mexico is expected to continue to be affected by headline risks around the US election. It is expected that, regardless of who wins the battle for the White House, the US will maintain its hardline rhetoric on China. US officials have questioned China’s investments in Mexico’s automobile industry, where Chinese-made steel, aluminium and electric vehicle components qualify as tariff-free in North America under the United-States-Mexico-Canada-Agreement (USMCA).² This issue could potentially trigger a renegotiation of part of the USMCA trade deal.³

Moreover, a potential victory for the Republican Party in the next US election could also bring changes to the migration policy and border controls aimed at discouraging migration into the US through the southern states. Migrant crossings at the border hit a record high of nearly 250,000 in 2023.⁴

Softer activity prompts central bank intervention

In Q2 2024, Mexico’s GDP grew only 0.2% quarter-on-quarter and decelerated to 1% year-on-year (YoY) from 1.8% in Q1. The IMF projects annual GDP growth to decelerate from 3.2% in 2023 to 2.2% by the end of this year because of reduced foreign investment and a negative spill-over from slower US growth.

Manufacturing activity has weakened since July due to moderating external demand. However, both manufacturing and services had a small but positive contribution to growth in the last quarter. These sectors have been hurt by a decline in consumption, reflecting high interest rates and inflation, while the depreciation of the Mexican peso has also impacted services. Primary activities, such as farming and mining, detracted from growth in Q2, after being in decline for more than a year.

Source: LSEG Data & Analytics and EFGAM. Data as of 22 August 2024.

The softening of economic activity supported Mexico’s central bank’s (Banxico) decision to cut interest rates by 25bps to 10.75% in August. Although in July headline inflation rose to 5.6% YoY, most of this increase followed rising food prices and reduced energy subsidies. Officials highlighted that although risks to headline inflation remain tilted to the upside, the shocks affecting prices are likely to fade in the coming months. Underlying inflation has consistently declined over the last year and a half and Banxico’s expectations are that it will converge gradually to the 3% target by Q4-2025.

The start of the rate-cutting cycle in March 2024 is expected to provide a boost to economic activity and benefit domestically oriented sectors in the medium term. However, in the short term, Mexican stocks will continue to struggle with headline risks associated with an incoming government that will have enough power in Congress to make significant changes to the Constitution. Therefore, in the context of a soft-landing scenario for the US economy, investors should focus on sectors that can benefit from better external conditions and a weak currency.

To conclude, risks remain high in Mexico given the number of bad news already priced in, the potential for further negative headlines around the US election and the uncertainty from the incoming new Mexican government. Economic activity has decelerated this year. However, the possibility of a soft-landing in the US, combined with a victory for the Democratic Party in the US election that would imply a continuation of current immigration policies, and Banxico’s monetary policy easing cycle, leads us to maintain a positive view for the medium term.

¹ A supermajority is defined as one single party winning more than two-thirds majority in either the Lower House or the Senate. In Mexico, this special majority is required to reform the constitution.

² https://www.wsj.com/articles/the-biden-trump-trade-war-with-mexico-electric-vehicles-usmca-9a093d77

³ It is important to highlight that between 1999 and 2024, Chinese FDI into Mexico accounted for USD 2.5 billion, representing less than 0.5% of total foreign direct investment in Mexico.

⁴ https://www.pewresearch.org/short-reads/2024/02/15/migrant-encounters-at-the-us-mexico-border-hit-a-record-high-at-the-end-of-2023/

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