Slow Growth Leaves Peso Bulls Stranded

By Nicole Hong 

        One of the most popular bets in the foreign-exchange market is proving to be a huge letdown.
        Investors' hopes for a stronger Mexican peso haven't been fulfilled, as sluggish economic conditions on both sides of the U.S.-Mexico border weigh on the currency.
        Money managers piled into the peso after it sold off in the middle of last year, betting that a recovering economy in the U.S. and policy measures in Mexico would lead to a rebound in the currency's value. Around the start of this year, banks including Deutsche Bank AG said buying the peso was one of their top trades for 2014.
        But the U.S. economy expanded just 0.1% in the first three months of 2014, while Mexico has struggled with sluggish construction and weak domestic demand. Many investors also became frustrated by the slow pace of change in Mexico's energy sector, where new regulations allowing foreign investment are widely viewed as key to unlocking faster economic growth over the long term.
        The peso is up 0.6% against the dollar this year, trailing MSCI Inc.'s emerging-market currency index, which is up 1.5%. On Tuesday, the peso was trading at 12.96 per dollar. Mexican stocks also are down 2.2% this year, worse than the 0.1% gain in the MSCI Emerging Markets Index. Deutsche Bank remains bullish on the peso, but sees limited gains in the next few months, said Drausio Giacomelli, its head of emerging-markets research.
        Mexico's currency is one of several wagers, including bearish bets on gold and Treasurys, that have disappointed investors this year. With the peso no longer the potential moneymaker it appeared to be at the start of the year, some investors are chasing higher yields in less-stable economies such as South Africa and Turkey.
        "The Mexican peso just hasn't lived up to expectations," said Ward Brown, a Boston-based portfolio manager at MFS Investment Management, which oversees $420.6 billion. Mr. Brown reduced his positions in the Mexican peso and Mexico's sovereign bonds earlier this year.
        The Mexican economy expanded only 1.1% in 2013, the lowest since 2009, and grew just 1.4% in the first two months of this year.
        The weak economy has prompted the Bank of Mexico to keep interest rates at a record low 3.5% to encourage borrowing. That puts pressure on the peso because investors can find higher returns elsewhere in the emerging world.
        Brazil, for instance, has raised its benchmark interest rate nine times in the past year to 10.75%. Money has poured into Brazilian debt and the real this year, even though many analysts and investors say Mexico's economy is in better shape.
        "The macro story in Brazil is infinitely worse than in Mexico, but capital is flowing to Brazil because the yields are much higher there," said Alberto Ramos, chief Latin America economist for Goldman Sachs Group Inc.
        But the peso still takes a hit when investors sour on developing economies. The currency is one of the world's most heavily traded, making it the easiest emerging-market currency to sell during a global market rout.
        "When we go through a bout of risk aversion...the peso gets whacked pretty quickly," said Paresh Upadhyaya, director of currencies at Boston's Pioneer Investments, which manages $238 billion. "The peso doesn't get any traction from the stronger, long-term fundamentals that underpin the currency." Mr. Upadhyaya has maintained bullish bets on the peso over the past year, calling the bets "frustrating."
        Many peso holders say they aren't ready to give in. They say constitutional amendments allowing foreign companies to invest in Mexico's energy sector will boost demand for pesos for years to come. The amendments passed in December, but Congress hasn't yet approved laws to implement changes.
        Long term, the peso is still better positioned than most emerging-market currencies, especially if the Federal Reserve begins raising rates next year, investors say.
        "We're still confident the stronger peso will eventually materialize, just at a slower pace," said Tom Nakamura, a portfolio manager at AGF Management Ltd. in Toronto, which oversees $36 billion. Mr. Nakamura added to his bullish bets on the peso in April.
        Write to Nicole Hong at nicole.hong@wsj.com
        (END) Dow Jones Newswires

        May 07, 2014 18:48 ET (22:48 GMT)