Mexico was upgraded to investment grade quality by Moody's last week sparking a rally in its governm...
Mexico was upgraded to investment grade quality by Moody's last week sparking a rally in its government paper.
Standard & Poor's has yet to adjust its own credit rating of Mexico, but the promotion to Baa3 quality by Moody's means that Mexico will now be included in government debt indices for Salomon Smith Barney and Lehman Brothers. Funds which track these indices will now have to invest in Mexican debt.
Paul Murray John, fund manager at Scudder Threadneedle, says: "Mexico has progressed along the classic reform path which investors like to see. Everything has fallen into place - monetary and fiscal policy and structural reform. Now it is investment grade quality, those investors which cannot invest in sub-investment grade paper will be able to buy it. This will gather more support for the assets."
He says that the trade agreement with NAFTA, strong growth in the US, and growth in Mexico's exports were the prime drivers in credit quality improvement. When the announcement was made, the spread on the Mexican 26 year bond narrowed to 230 basis points over the equivalent US Treasury from over 300 basis points. According to Schroders director, Robert Davy, it could go even lower, to between 150 to 200 basis points.
He warns that continuing success for Mexico relies upon foreign capital inflows. A massive increase in short term interest rates would threaten such cashflow, particularly in the US, which is Mexico's largest export destination and investor.
He says: "The upgrade will help Latin America to attract capital at a time when the US is raising its interest rates." For those fund managers seeking yield, like Murray John, it is time to sell out and find higher yields elsewhere.
He says: "Brazil is next best opportunity after Mexico. We are beginning to see the start of a period of economic growth. In particular, domestic growth is moving higher, which was not the case before because growth was limited to export markets only."
Finding yield however is relatively difficult as economic conditions improve around the world. Murray John is currently overweighting Brazil and Russia. In Brazil, the long bond has a 6% yield over the equivalent 30-year US Treasury currently yielding 6% and the Russian 30 year Eurobond has a 9% extra yield over the US long bond.
He says: "There is higher risk in Russia but it has come to an agreement with the lenders of the dollar-denominated debt it defaulted on. That is all signed and sealed and there is no reason why it should not go ahead.
"The economy has improved a great deal. The devaluation of the rouble and rising commodity prices has helped its exports, while it has been responsible and reasonably orthodox in its domestic policies. In addition, the IMF is continuing to lend Russia money."
Concern over the forthcoming elections in Russia is abating, as it appears Vladimir Putin, currently acting president, will move seamlessly into the official role. The visit of Prime Minister Tony Blair demonstrates that Russia is facing the reality of needing to borrow from the West and will act responsibly, Murray John considers.
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