Mexico - Time For A Debt Downgrade?

For the second time in as many days the Mexican central bank has intervened in the currency markets to prop up the Mexican peso. In my previous post, What Happens in Mexico, Stays in Mexico?, I outlined the challenges the Mexican government and economy are facing. Despite having the foresight to hedge 2009 oil prices, Mexico is fighting a drug war, it faces declining exports, and a depletion of its oil fields.

As would be expected in this environment the credit default swap spreads have begun to widen for Mexico. What is surprising is when Mexican CDS spreads compared to Brazil. Mexico is currently rated Baa1 by Moodys and BBB+ by S&P, while Brazil is rated lower with a Ba1 from Moodys and BBB- from S&P. Curiously, the cost to insure the default of both countries has been trading at virtually the same level, implying the same risk of default.

As expected, during the acute phase of the economic crisis last fall, the cost to insure the debt of both countries surged. Since Brazil is rated three notches below Mexico, the cost to insure Brazilian sovereign debt traded at higher levels.

However recently this trend has reversed and now it costs more to insure Mexico’s sovereign debt. The chart above graphically illustrates that Mexican CDS spreads are now higher than Brazilian spreads. It appears that while the Mexican central bank has been trying to shore up international confidence by defending its currency, the opposite has occurred. Rarely does currency intervention work, usually the central bank runs out of money, stops the intervention ,and the currency falls. Mike Shedlock, a.k.a Mish, has a great post on the intervention madness that is sweeping the globe.

There are really two outcomes to this anomaly, either Mexico gets downgraded or Brazilian CDS begin to rise. Given the political turmoil Mexico and its reliance on the US economy, the more probable scenario is continued weakness in the Mexican peso and bond market, with the potential for a downgrade.

Disclosure: I am short FXM and EMB.

Subscribe by RSS Subscribe by Email