July 5, 2019 / 6:09 PM / 3 months ago

Foreign bond buyers lift Mexico peso despite trade threats, downgrades

MEXICO CITY, July 5 (Reuters) - Mexico's peso, which swung wildly in early June after a Fitch downgrade and brief U.S. threat to impose tariffs, has steadied as the country's high interest rates attracted foreign buyers of bonds using borrowed money, analysts and economists said.

Under the "carry trade" strategy, investors borrow money in the currency of a country with low interest rates, such as the United States and some European countries, to buy bonds of a high-yield country like Mexico.

Mexico's Central Bank has kept its benchmark interest rate steady at 8.25% since hiking it in December to the highest level among all emerging countries except Turkey and Argentina.

The U.S. Federal Reserve's rate is 2.25%-2.50%.

"To the extent that the spread of rates was increasing, the carry trade began to become more important," said Gabriela Siller, an economist at Mexican bank Banco Base.

Since December 2015 the spread has doubled as the central bank raised rates to contain inflationary pressures, and foreign holdings of Mexican debt have grown by 87.2 billion pesos ($4.58 billion).

Mexico's President Andres Manuel Lopez Obrador regularly boasts of a strong economy, citing the peso as proof, despite a first-quarter contraction and signs of faltering investor confidence.

U.S. President Donald Trump vowed on May 30 to impose a tariff on all Mexican imports to stem a surge of illegal immigrants across the southern border, but suspended the threat after a bilateral deal was reached.

Fitch Ratings Inc downgraded Mexico's sovereign debt on June 5, citing trade tensions and risks from heavily indebted oil company Petroleos Mexicanos, or Pemex, while Moody's lowered its outlook to negative.

The peso has strengthened 3.1% this year, to 19.0244 to the dollar on Friday, after slumping in the final 2018 quarter on Lopez Obrador's decision to cancel a partly built $13 billion airport for Mexico City.

"It's not more optimism; it's the high yield that has attracted more capital and has sustained the exchange rate," said Siller.

Some analysts predict that as long as the U.S.-Mexico spread remains high, the carry trade will sustain the peso.

Joel Martinez, an economist at brokerage firm SIF ICAP, said Mexico is attractive also to investors in countries with low current account deficits and reasonable debt-to-GDP ratios.

Dollar inflows to Mexico from U.S. trade have also supported the exchange rate, with a growing surplus, he added.

Mexico logged a trade surplus of $101.7 million between January and May this year in seasonally adjusted terms, according to official data, compared with a deficit of $4.30 billion in the same period 2018.

"The balance of payments is healthy," said Martinez.

($1 = 19.0408 Mexican pesos)

Reporting by Abraham Gonzalez; Writing by Daina Beth Solomon; Editing by Anthony Esposito and Richard Chang

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