Mexico Bond Risk Tops Brazil for 1st Time Since 2001

By Lester Pimentel

Feb. 20 (Bloomberg) -- Mexico is riskier than Brazil in the bond market for the first time since at least 2001 as a war with drug traffickers, slowing exports to the U.S. and a record-low peso drive away investors.

Five-year credit-default swaps tied to Mexico’s bonds and used to hedge against losses traded at 4.19 percentage points yesterday, compared with 3.94 points for Brazil, according to data compiled by Bloomberg. The gap widened to a record 0.43 percentage point on Feb. 17, reversing a seven-year stretch when the cost to protect against a default in Brazil was higher.

Mexican bonds are this year’s worst performers in Latin America after drug-related deaths climbed to 5,300 in 2008, the peso sank 32 percent in six months and a recession deepened in the U.S., the buyer of 80 percent of the country’s exports. In Brazil, which relies on the U.S. for 14 percent of overseas sales, the Bovespa Stock Index is up 5.8 percent this year, compared with a 16.5 percent decline for Mexico’s Bolsa.

“The death numbers are pretty scary,” said Michael Atkin, who helps oversee $12 billion in fixed-income assets as head of sovereign research at Putnam Investments in Boston. “Mexico is much more integrated with the U.S. Brazil is more able to ride out the economic downturn.”

Yields on Mexico’s 6.75 percent dollar bonds due in 2034 are higher than those on similar-maturity Brazilian bonds even though Mexican debt is rated higher. Mexico’s bonds yielded 7.55 percent, 10 basis points, or 0.1 percentage point, more than the yield on Brazilian securities.

Failed Bond Sale

Mexico’s dollar bonds on average lost 4.8 percent since Dec. 31, the biggest decline in the region, according to Merrill Lynch & Co. The debt is rated Baa1 by Moody’s Investors Service and BBB+ by Standard & Poor’s. Brazil is rated three levels lower by Moody’s and two lower by S&P.

It costs $419,000 to insure $10 million of Mexican debt with credit-default swaps, compared with $394,000 for Brazil. Credit- default swaps pay the buyer face value if a country defaults in exchange for the underlying securities or the cash equivalent.

The gap may keep growing, said Edwin Gutierrez, who manages $5 billion of emerging-market debt at Aberdeen Asset Management Plc in London. “You don’t want to stand in front of that train,” he said. “People are concerned about the sensitivity of Mexico to the U.S.”

Investors scuttled Mexico’s planned sale of 21-year bonds on Feb. 11, the first time that weak demand forced a Latin American country to cancel part of a debt offering since Uruguay did in 2005, according to Royal Bank of Scotland.

Budget Deficits

Earlier this decade, prices for the countries’ credit default swaps were reversed. Protecting Mexican debt cost an average of $129,000 from 2001 to 2008, according to data compiled by Bloomberg. In Brazil, which has posted budget deficits as big as 7.9 percent of gross domestic product in the past 10 years, the average cost was $563,000.

“Mexico does have a longer and better track record of managing fiscal downturns,” Atkin said.

Brazil had an average budget deficit equal to 3.1 percent of gross domestic product over the past six years. Mexico, Latin America’s second-biggest economy after Brazil, posted an average gap of 0.2 percent.

Debt prices are bound to flip back, said Paul Biszko, a senior emerging-markets strategist with RBC Capital Markets in Toronto. “A reversal is quite likely” once investors realize Brazil is almost as vulnerable as Mexico to the global slump that began in the U.S., he said.

Gang Violence

Credit-default swap rates converged as the U.S. recession cut Mexican exports by 14 percent in the fourth quarter and reduced migrant worker remittances for the first time since the central bank began tracking transfers in 1995.

The drug war is eroding investor confidence and reducing annual gross domestic product by 1 percentage point, according to the government. Narcotics-related deaths more than doubled last year as President Felipe Calderon’s crackdown increased competition between gangs for the best supply routes to the U.S.

“There’s a lot of focus on drugs and crime in Mexico,” said Jonathan Binder, who manages more than $2 billion at INTL Consilium LLC in Fort Lauderdale, Florida. “It’s one of the hot topics that has come through.”

Atkin said the war, which has deteriorated into decapitations and grenade attacks, raises questions about “the fundamental stability of the country.”

1994 Peso Devaluation

Mexico’s economy will shrink 1.2 percent this year, the first contraction since 2001, according to the average estimate of 31 analysts in a central bank survey published Feb. 3. Brazil will expand 1.5 percent, a central bank survey of about 100 economists showed on Feb. 13.

Brazil “is not as exposed to the U.S.,” said Cathy Elmore, who manages $700 million of emerging-market debt at WestLB Mellon Asset U.K. Ltd. in London. “It’s been operating more on domestic demand.”

Mexico had a current account deficit, the broadest measure of trade, of $6.6 billion in the fourth quarter, according to the median of six economists in a Bloomberg survey. That would be the widest since the 1994 deficit that triggered a 49 percent peso devaluation.

Oil is responsible for much of the decline because Mexico is the third-biggest supplier to the U.S. The country’s crude production fell last year at the fastest pace since 1942 at the same time that prices plunged 74 percent from a July record.

Banco de Mexico spent $18 billion in the foreign exchange market in the past six months in a bid to shore up the peso. The currency dropped to a record low of 14.8150 per dollar today.

“The Mexican peso is on its backfoot and requiring intervention,” said Aberdeen’s Gutierrez. “The world is negative on Mexico.”

To contact the reporter on this story: Lester Pimentel in New York at lpimentel1@bloomberg.net