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Yield hunters follow the trail of the peso

15 Sep 2005

The Mexican peso market has grabbed the headlines this year as the latest niche currency sector to offer investors an alternative to record tight yields in other more established areas. Alistair Dawber looks at the reasons for the success of the market and asks whether it is here to stay.

It's all about the yield. And with returns pushing a bountiful 10%, it is hardly surprising that the Mexican peso market has enjoyed the attention of niche currency Eurobond investors over the last six months.

At a time when more traditional retail bond markets are offering record tight returns, and in the wake of credit events such as the GM and Ford downgrades, investors are increasingly happy to make a play on the currency.

"The story of the Mexican peso market is all about the international hunt for yield," says Holger Kron, head of niche currencies at Deutsche Bank in Frankfurt.

"Yields are low in all the core markets and investors are seeing currencies like this as an alternative option — the market offers buyers a great chance to diversify."

The market first came to prominence with the inaugural Eurobond deal in March in the form of a Ps500m offering from the Inter-American Development Bank (IADB).

Since that trade, the market has attracted the attention of other top rated borrowers that have become regulars in the higher yielding, non–core sectors.

Sandeep Dhawan, senior capital markets officer at the European Investment Bank (EIB) in Luxembourg, agrees that tightening yields in other, more traditional retail markets has led to the peso sector's prominence. 

"Convergence of markets, particularly in eastern Europe, continues to gather momentum," he says. "The consequent reduction in yields in these local currencies is necessitating investors to look at other markets that offer a reasonably stable currency regime accompanied by attractive yield pick-up. The Mexican peso sector is one such market where yields of some 9%-10% are available along with a very developed cash and swaps market."

It's the economy, stupid
But it is not just the fact that yields have collapsed everywhere else that has sustained peso issuance. Economic development in Mexico has gathered pace since the start of the decade and this has given investors more confidence in the stability of the market.

According to Deutsche's Kron: "The market has come to prominence for a number of economic reasons. Inflation has dropped from 19% in 1999 to around 5% this year and of course, interest rate levels have reflected this move. Growth is steady at about 4.5%. In addition to the improving economic picture is the fact that over the last five years the Mexican government has created a proper benchmark curve, which helps to make yields more transparent — all of which gives investors much more confidence."

Here to stay?
Investors' hunt for yield has not diminished the desire for credit quality — triple-A rated agency and supranational borrowers dominate the peso market.

There have been 31 trades since the IADB offering in March, bringing $1.343bn worth of debt. Between them, the EIB and the German development bank, KfW, have dominated the sector bringing $469m worth of trades, accounting for 45% of all offerings.

Corporate credits have also been active. The first to offer a bond was Toyota Motor Credit Corp that came with a Ps500m issue in June, while GECC took the plaudits in July for a Ps1bn deal.

In the past these credits have brought trades to a number of niche currency sectors, but traditionally volumes have fallen off after the initial, headline-grabbing transactions.

The South African rand market now sees little issuance after a surge in 1999 and now there is precious little activity in the eastern European currency markets. However, those that have helped to establish the peso market argue that it could survive longer than a few months.

"So long as yields remain unattractive elsewhere and nominal rates in Mexico stay high, the outlook for the peso sector remains positive," says John Greenslade, global head of international fixed income at TD Securities in London. "We are confident that the market will be around for some time to come."

This is the market consensus, with others starting to compare Mexico's position in the same light as that of Canada, as an alternative to US dollar investment.

"We are optimistic on the longevity of the peso market," says Klaus Hansen, a syndicate official at UBS in Zurich. "Mexico's is a good story and the economy is really making gains. In a few years time it would not surprise me if Mexico became the equivalent of Canada in the south."

Turkish comparisons
The peso market has shared the non-core limelight this year with the Turkish lira , which has seen a rash of trades since January.

"The Mexican peso market has followed a very similar path to that of the Turkish lira sector earlier in the year," says Petra Wehlert, head of new issues at KfW in Frankfurt. "It is driven by the high coupons which have attracted retail and smaller institutional investors mainly in Europe."

However, others, while acknowledging the similarities between the two markets, have also pointed out that there are differences between the sectors.

"While the Turkish lira market is more of an EU convergence play which took off on the back of the currency redenomination at the start of this year," says Greenslade at TD. "The peso sector is a diversification play that has come to prominence off the back of appealing economic performance and an improving credit story."

What is certain is that issuers and syndicate desks will continue to look at other currency markets as yields elsewhere dry up.

"There are a number of markets that we are watching and that we think might have potential," says Hansen at UBS.

"The economies need to be bigger like those in Turkey or Mexico. The Brazilian real could be exciting if economic reforms could be made to ensure that the currency is freer." 

15 Sep 2005