Bonds Get Safer Versus Brazil on Oil Revenue, U.S. Growth: Mexico Credit

Mexico’s surging oil revenue and economic expansion are pushing the country’s bond risk to a 10- month low relative to Brazil.

The cost of protecting Mexican debt against non-payment for five years with credit-default swaps is 7 basis points, or 0.07 percentage point, less than similar contracts for Brazil, the biggest gap since May 3, according to prices from data provider CMA. Investors paid a record 72 basis points more to insure Mexican debt rather than Brazilian bonds in March 2009 as slumping exports to the U.S. and declining oil output swelled the Mexican budget deficit and sparked credit-rating cuts.

The 30 percent rally in crude, Mexico’s second-biggest export, and growing trade with the U.S. may fuel economic growth for a second year after the worst recession since 1995 and increase revenue, according to Finance Minister Ernesto Cordero. While inflation in Mexico slowed to 3.1 percent in the 12 months through mid-March, consumer prices in Brazil rose 6.1 percent during the period.

“It’s clear with this improvement in GDP prospects and with inflation expectations that are not accelerating that investor confidence in Mexico is going north,” said Jean- Dominique Butikofer, who helps oversee about $1 billion of emerging-market debt at Union Bancaire Privee in Zurich. Mexico “may have stronger growth than expected, while the jury may still be out on Brazil,” he said.

Credit Ratings

Mexican dollar bonds posted a return of 1.7 percent this year, compared with a gain of 0.7 percent for Brazilian debt, according to JPMorgan Chase & Co.’s EMBI+ indexes. Mexico’s 5.95 percent dollar notes due in 2019 yield 4.23 percent. Brazil’s 5.875 percent bonds due the same year also yield 4.23 percent.

Mexican debt is rated BBB by S&P and Fitch Ratings, one level above Brazil and the second-lowest investment grade, after the companies lowered the rankings in 2009 by one step. The country’s Baal ranking from Moody’s is two steps above Brazil.

An official in the Finance Ministry’s press office didn’t respond to an e-mail seeking comment. A Brazilian Finance Ministry press official declined to comment.

State-owned Petroleos Mexicanos, Latin America’s biggest oil producer, generates about a third of government revenue. Oil traded at $105 a barrel yesterday and reached a 30-month high on March 7 as unrest in North Africa disrupted supplies and threatened to spread to the Middle East.

Pemex, as the company is known, will produce more than 2.6 million barrels of crude a day in 2011, up from a previous estimate of 2.55 million, Chief Executive Officer Juan Jose Suarez Coppel said March 18 at an event in Ciudad del Carmen in Mexico’s Campeche state. Last year, Mexico’s oil output dropped to 2.576 million barrels a day, its lowest level in 20 years.

Budget Deficit

Mexico’s budget deficit will shrink to 2.5 percent of gross domestic product this year from 2.8 percent in 2010, according to the median estimate of five economists in a Bloomberg survey. The economy may grow of as much as 5 percent this year after a 5.5 percent expansion in 2010, the fastest in a decade, Cordero said.

Mexican GDP grew 5.85 percent in January from a year earlier, topping the 5.6 percent expansion forecast by the median estimate of 11 analysts surveyed by Bloomberg.

“Higher oil does help Mexico’s external account,” Henry Stipp, who helps manage about $2 billion of emerging-market securities at London-based Threadneedle Asset Management, said in a telephone interview. “Now things start to go back to normal more or less.”

Default Swaps

Mexico’s five-year default swaps have traded an average of 66 basis points below those of Brazil since 2004, when CMA data began. It cost as much as 361 basis points more to protect Brazilian debt in October 2004.

The cost to protect Mexican debt against non-payment for five years dropped 2 basis points yesterday to 106, according to CMA. Credit-default swaps pay the buyer face value in exchange for the underlying securities or cash equivalent if the issuer fails to comply with debt agreements.

The extra yield investors demand to hold Mexican dollar bonds instead of U.S. Treasuries widened 3 basis points to 131, according to JPMorgan.

The peso gained 0.2 percent to 11.95515 per dollar and is up 3.2 percent this year.

Yields on the TIIE futures contract maturing in July fell 1 basis point to 5 percent.

Central bank Governor Agustin Carstens will increase the overnight lending rate about 75 basis points to 5.25 percent by year-end, trading in 28-day interbank rate futures contracts known as TIIE futures shows. Mexico is the only major Latin American country that hasn’t boosted borrowing costs in the past year as consumer prices rise at the third-slowest pace in the region after Chile and Peru.

Rate Boosts

Brazil’s central bank raised its benchmark rate by 50 basis points twice this year to 11.75 percent to stem inflation running at the fastest pace in 28 months. The country’s economy may expand 4.1 percent this year after growing 7.5 percent in 2010, according to the median estimate of 14 economists in a Bloomberg survey.

Mexican policymakers have kept their key lending rate at a record low 4.5 percent for a record 17 meetings. The economy shrank 6.1 percent in 2009 after the U.S. slipped into recession. The U.S. economy, which buys 80 percent of Mexico’s exports, may grow 3.1 percent this year after expanding 2.9 percent in 2010, according to the median estimate in a Bloomberg survey of 68 economists.

A slowdown in the U.S. expansion may push up Mexico’s bond risk relative to Brazil, according to Jeff Williams, an emerging-market debt strategist at Citigroup Inc. in New York.
‘Main Risk’

Confidence among U.S. consumers dropped more than forecast in March as fuel costs surged to the highest level in more than two years.

“The main risk is U.S. data starts disappointing,” Williams said in a telephone interview. “That’s going to hurt Mexico’s spread.”

Brazil’s efforts to curb the rally in the real are driving up its default swaps relative to Mexico, said Union Bancaire Privee’s Butikofer. The real is up 41 percent against the dollar since the end of 2008 compared with 14 percent for Mexico’s peso.

Brazil raised taxes yesterday on corporate loans and bank bond sales in international markets in a bid to contain the two- year rally in the real that’s crimping exporters’ profits. The move follows a tripling of a tax on foreign investors’ fixed- income purchases to 6 percent in October and central bank dollar purchases totaling $18.8 billion in the currency market this year.

“The latest growth data in Mexico came out significantly higher than expected,” Butikofer said. “That is something where people have paid really strong attention. The Mexican peso has been really floating. We haven’t seen the Mexican central bank curb capital inflows, hot money. If you look at the two countries, Mexico is catching up.”