(Bloomberg) A gauge of U.S. consumer prices jumped by the most in a decade in July, eating into wage gains that have barely budged in the past four months and strengthening the case for the Federal Reserve to keep raising interest rates gradually.  The core measure of the Consumer Price Index, which excludes food and fuel, rose 2.4 percent from a year earlier, the biggest advance since September 2008, a Labor Department report showed Friday. From the prior month, both the main CPI index and core rate rose 0.2 percent -- matching expectations.

Policymakers are widely projected to lift borrowing costs when they meet in September, with many investors expecting an additional hike before the end of this year. Inflation has made progress, and the unemployment rate, at 3.9 percent in July, signals the Fed is near its maximum-employment goal.

Trade may become a source of price pressures. In picking Chinese goods to target for tariffs, the Trump administration has tried to avoid directly taxing consumer goods. But that’s getting harder to do as trade tensions escalate. A list of Chinese products due to be hit with tariffs next month includes consumer items such as digital cameras, selfie sticks and electric scooters.

(Bloomberg) Global stocks declined and the lira weakened as Turkey’s economic crisis threatened to spread. The dollar rose with Treasuries after inflation data.  The S&P 500 Index erased a weekly advance after President Donald Trump doubled tariffs on Turkish steel and aluminum imports, escalating a diplomatic row that tipped the nation’s economy deeper into crisis. European and emerging-market equities slid more than 1 percent after President Recep Erdogan’s remarks failed to reassure global markets. The 10-year yield slid to 2.90 percent as data reinforced the Federal Reserve’s rate-hike intentions.  

Geopolitical tensions between the U.S. and other countries set the tone for markets this week, with the latest leg of the lira’s downward spiral triggered by a diplomatic row with America. Earlier, China responded to the Trump administration’s trade war volley with additional tariffs of its own. The ruble hit a two-year low after the U.S. announced new sanctions on Russia over a nerve-agent attack in the U.K.

(CNBC) U.S. government debt yields held at session lows Thursday after the U.S. government reported that producer prices rose less than expected in July, one possible sign of anemic inflation in the economy.

The yield on the benchmark 10-year Treasury note was 3 basis points lower at around 2.939 percent at 9:28 a.m. ET, while the yield on the 30-year Treasury bond was also lower at 3.095 percent. Bond yields move inversely to prices.

The U.S. Labor Department said Thursday that its U.S. producer price index was unchanged in July, falling short of a 0.2 percent increase expected by economists polled by Reuters. The producer price index minus volatile food, energy and trade components, rose 0.3 percent after a similar gain in June. 

In the 12 months through July, the core PPI increased 2.8 percent after rising 2.7 percent in June. The lackluster reading comes as the economy reaches full employment and strong growth; individual reads on inflation are expected to rise as the Trump administration's tariffs on lumber, steel, aluminum and Chinese goods start to influence price pressures.

(Bloomberg) The U.S. announced new sanctions on Russia in response to the March 4 nerve-agent attack in the U.K., with lawmakers seeking “crushing sanctions” under a separate bill for election interference. The ruble extended its steepest slide in almost two years and government bonds slumped this morning. The largest ETFs tracking Russian stocks saw trading volumes soar after the measures were announced.

(Bloomberg) The biggest question on Wall Street enters a third day without an answer: Where’s the “funding secured” that Tesla Inc.’s Elon Musk tweeted about when he said he was thinking of taking the company private? Bloomberg reported that Musk had talks with SoftBank Group Corp. last year with a view to taking the electric-car maker private, but the meeting failed to progress due to disagreements over ownership. People at, or close to, 15 major financial institutions and technology firms said they weren’t aware of financing being locked-in before Musk’s tweet. Shares in the company closed down 2.4 percent at $370.34 yesterday and are slipping in pre-market trading.

(Bloomberg) Turkey’s lira fell to a new record low of 5.449 to the dollar, taking losses for the currency this year to close to 30 percent as investors fret about the outlook for the country’s economy and worsening relations with the U.S. Today’s sell-off comes after a Turkish delegation to Washington refused to commit to releasing a detained American pastor, whose arrest was the catalyst for the imposition of U.S. sanctions on its NATO ally. The situation has deteriorated so much that bankers and traders are talking about the prospect of an International Monetary Fund rescue.

(Bloomberg) U.S. stocks rose within striking distance of records amid optimism economic growth can continue apace even as the world’s two largest economies square off in a trade skirmish. The dollar slid the most in two weeks. The S&P 500 Index hit the highest level since Jan. 29 and the Cboe Volatility Index dipped below 11 for the first time since May. Miners lifted the Stoxx Europe 600 Index as commodities advanced. Chinese stocks led a broad rally in Asia, with the Shanghai Composite Index posting its biggest gain in two years on hopes for more policy support for investment.The gains in emerging-market equities overshadowed rising woes in Turkey, where the yield on the country’s 10-year bonds touched a record high amid a diplomatic spat with the U.S. The lira clawed its way back from a record low, only to later give up some gains.

As earnings season enters its final phase, most major U.S. companies have now reported and about four out of five have surprised to the upside. That’s pushed the S&P 500 within 25 points of a record, even as investors fret over the escalating trade war between America and China. Meanwhile, geopolitical concerns linger in the background, including confusion about the status of negotiations intended to lead to the denuclearization of the Korean peninsula and the Trump administration’s restoration of some U.S. sanctions on Iran.

Elsewhere, crude climbed after Saudi Arabian production cuts added to concern about tightening worldwide supplies. Gold advanced with industrial metals. European sovereign bonds were mostly lower, with Italian notes rising. The yen strengthened after Reuters reported that the Bank of Japan had considered raising interest rates this year. Germany’s industrial production fell more than expected in June, but the euro strengthened after a recent run of losses.

(Bloomberg) U.S. stocks rose within striking distance of records amid optimism economic growth can continue apace even as the world’s two largest economies square off in a trade skirmish. The dollar slid the most in two weeks. The S&P 500 Index hit the highest level since Jan. 29 and the Cboe Volatility Index dipped below 11 for the first time since May. Miners lifted the Stoxx Europe 600 Index as commodities advanced. Chinese stocks led a broad rally in Asia, with the Shanghai Composite Index posting its biggest gain in two years on hopes for more policy support for investment.The gains in emerging-market equities overshadowed rising woes in Turkey, where the yield on the country’s 10-year bonds touched a record high amid a diplomatic spat with the U.S. The lira clawed its way back from a record low, only to later give up some gains.

As earnings season enters its final phase, most major U.S. companies have now reported and about four out of five have surprised to the upside. That’s pushed the S&P 500 within 25 points of a record, even as investors fret over the escalating trade war between America and China. Meanwhile, geopolitical concerns linger in the background, including confusion about the status of negotiations intended to lead to the denuclearization of the Korean peninsula and the Trump administration’s restoration of some U.S. sanctions on Iran.

Elsewhere, crude climbed after Saudi Arabian production cuts added to concern about tightening worldwide supplies. Gold advanced with industrial metals. European sovereign bonds were mostly lower, with Italian notes rising. The yen strengthened after Reuters reported that the Bank of Japan had considered raising interest rates this year. Germany’s industrial production fell more than expected in June, but the euro strengthened after a recent run of losses.

(Bloomberg) China let it be known that it’s in the trade war for the long haul, explaining in an editorial published in state media that it doesn’t fear sacrificing short-term economic interests. The comments came in response to President Donald Trump’s tweet that he has the upper hand. On Friday, Beijing released a tariff list designed to retaliate against the American threat to impose new duties on $200 billion of Chinese imports. While China’s economy is showing the biggest strains from the tension, pressures are also mounting in industries across the world, from oil markets to U.S. newspapers.

July 01, 2018 saw a historic shift in the centre of gravity in Mexican politics with the left-wing MORENA[1] party candidate, Andres Manuel Lopez Obrador (AMLO), winning the country’s presidential elections and Mexican bonds and the peso have rallied in its wake. ALMO received a strong mandate, winning close to 53% of the votes. The MORENA party and AMLO’s political coalition will now  be the  largest group in the Mexican Congress, providing a solid base for the president-elect to implement his legislative agenda. The markets appears to be embracing this shift in the political landscape thus far, as the average price on Mexican corporate bonds have been rising steadily while the Mexican Peso has appreciated 6.64% since the election.  However, there still some uncertainty in the market related to the on-going NAFTA negotiations and how the government intends to fund its spending plans which is expected to translate into continued volatility for Mexican bonds.  

Although AMLO’s administration will be inheriting an economy characterized by deeply entrenched fiscal discipline, favourable macroeconomic fundamentals, and a respectable (BBB+) credit profile, it will face headwinds from on-going NAFTA negotiations and the incoming administration’s spending plans.  The administration has committed to boosting social and infrastructure investments and implementing policies to improve the lives of the poor and marginalized; which for the budget, appears to place and increased emphasis on spending. It will also have to contend with Trump’s protectionist policies and negotiating a favourable NAFTA agreement.  We expect these two issues to continue to dominate the Mexican narrative and will be the key drivers of volatility within the Mexican Markets over the next 6 to 12 months. However, the expectation is that that there will be continuity in observing prudent fiscal policy, at least over the short to medium term, given the  new administration’s commitment to maintaining fiscal discipline- not increasing the public debt.   Additionally, despite the President Trump’s protectionist rhetoric and the seemingly interminable squabbles around NAFTA, the expectation is that the three parties will come to an agreement, which for the most part, preserves the trade bloc.

AMLO Pledges Fiscal Prudence

While the new administration has pledged to maintain the course of fiscal discipline over the short term by sticking to the guidelines already presented to Congress back in April., a key challenge it will face is financing a budget which is heavily skewed towards spending.   In his victory speech the president-elect vowed that he has no intentions to raise taxes, rack up debts, or interfere with central-bank’s independence. He also pledged to increase public investment, aiming to lift this amount to 5% of GDP over the medium to long-term, placing greater emphasis on social spending. ALMO has plans to create friendly environment for investors and has indicated he has no intentions of reversing policies which allowed for the privatization Mexico’s oil sector. The newly elected president had said the budget can be funded through savings by prioritizing a few important projects and streamlining the government’s procurement process, thereby reducing costs and corruption levels. However, analysts are wary of this proposition as it seems more like a panacea than a solid economic plan.   Further, the concern is that the new administration’s proclivity towards spending could put Mexico on the same path as Argentina and Brazil, both of which ran sizeable deficits causing deterioration in their fiscal position and credit profile.

NAFTA critical

The NAFTA renegotiation process and President Trump’s protectionist policies will continue to transfuse much uncertainty into the Mexican economy.  NAFTA plays an integral role in the Mexican economy, having a profound impact on the flow of trade and investments to Mexico and has contributed significantly to the country’s growth[2]  since the partnership was formed back in the early 1990’s. The agreement is also a key pillar in the country’s modernization efforts. Arguably, Mexico has the biggest stake in ensuring an amicable conclusion to the on-going NAFTA discussions given that the country has the largest exposure to trade of the three NAFTA countries[3]. However, unfortunately for Mexico, its vested interest in the agreement is not commensurate with its position at the table as the terms of current discussions are more less dictated by the  US and Canada .

The Manufacturing sector, which accounts for over 80% of the country’s exports^[4] to the US, is expected to be most heavily impacted by any retreat in from NAFTA.  This would no doubt have a significant impact on the country’s GDP as domestic demand would not be sufficient to replace the reduction in US demand.   Additionally, since the industries are supported by the tertiary/service sector,  a retreat from NAFTA would also have an adverse second order effect on support sectors such as the financial services. However, despite the current impasse, observers such as Fitch and Standard and Poor’s (S&P) are expecting a favourable conclusion to the talks that does not materially disrupt Mexico's trade with the US. An amicable conclusion of the NAFTA discussions will go a far way in providing clarity and easing some of the angst about Mexico’s economic future.   This would also be good news for Mexican corporates such as Pemex (Oil and Gas) and Unifin Financiera (Financial).

Sovereign Rating Outlook

In its March 2, 2018 report, S&P maintained its BBB+ rating and  stable rating outlook   on Mexico based on expectations of continuity in economic policies in the coming two years, along with observation of fiscal prudence. The rating agency also expects the three governments involved to conclude the NAFTA renegotiation, to come to a new arrangement which largely preserves the cross-border trade and critical links that underpin the North American economy. Mexico’s current BBB+ rating could be at risk of a downgrade if GDP growth along with larger-than-expected fiscal deficits which could make it difficult for the administration to stabilize its debt as a share of GDP over the next two years. Likewise, radical shifts in energy policies which could threaten the financial health of Petroleos Mexicanos (Pemex) and Comision Federal de Electricidad (CFE) could inadvertently increase the sovereign’s debt. This would affect the country’s credit profile and make the sovereign more susceptible to external shock, thereby increasing its downgrade risk. 

Conclusion

The average price on Mexican corporate bonds fell as much 7.85% since the start of the year, reaching its lowest point in mid-June, fuelled by uncertainties related to NAFTA and concerns regarding the outcome of the elections. Consequent on AMLO’s victory at the start of July bond prices have rallied initially, with prices increases ranging from 0.65%- to 4.33% amid an orderly transition, AMLO softening of his tone around his policy agenda and greater certainty around the new administration ability to achieve its policy agenda due to its absolute majority in Congress,  One credit for which we currently have a buy recommendation, Unifin Financiera 2023 has shown persistent price improvements since the election, growing 4.33% over the period. On the other hand, despite rallying initially on the news of the election results, the price on Pemex 2028 is down 4.05% since the start of this week, reacting negatively to the President-elect’s recently announced appointment of a new head for the company. As the NAFTA talks evolve and the new administration transitions into office, we continue to anticipate this volatility in Mexican bond prices.  In light of this, we continue to encourage investors in Mexican corporates to seek out entities with strong fundamentals.

[1] Movimiento Regeneración Nacional

[2] Economically, politically and institutionally

[3] Approximately 81% of Mexican exports went to the United States in 2017.

[4] Primarily capital and consumer goods such as machinery and transportation.