Tag Archives: Mexico

Mexico: Ready for rise in US interest rates

It seems almost certain that at some point in the near future the interest rates in the United States are going to rise. Interest rates have been hovering around zero for several years now, and it is only a matter of time until they rise at least a little bit.


When this happens, it will not only have an effect on the domestic economy, but on the international economy as well as we have seen in class through the international finance diagrams. One country in particular that has struggled in the past with movements in the US interest rates is Mexico. However, according to Agustín Carstens, Governor of the Bank of Mexico, the country is in a much better place to handle an increase in US interest rates, whenever that may occur.

Previously, Mexico has suffered from movements in the US interest rates as they were not well prepared and not able to handle these changes very well. In the past, the issue would have looked something like this: the US increases interest rates, which would result in a movement along the US NCO curve up and to the left. This would then cause the supply of dollars to shift to the left, which would increase the exchange rate in the United States and lower net exports. Simultaneously in Mexico, this would cause the NCO curve to shift to the right and the supply of pesos to shift to the right as well, which would decrease the exchange rate and increase net exports. While an increase in net exports may not seem like such a bad thing, this would put Mexico above their natural level of output and may begin to overheat their economy.

But now that Mexico is better prepared and will be able to handle such an increase in US interest rates, this sort of trouble should not occur. “Mexico is trying to have this process of increase in interest rates as orderly as possible,” Ramos-Francia (Mexico’s central bank deputy governor) said. When in fact the US does raise interest rates, Mexico should be able to respond in such a way to stay at (or return after a brief stray from) their natural level of output. In order to do so, after an increase from the US, Mexico could sell bonds domestically to decrease their money supply in order to increase their interest rates. This should result in a partial decrease in investment and a movement up and to the left along their new NCO curve which would shift the supply curve of pesos to the left (about halfway between the original and the intermediate curve), decreasing net exports partially and increasing the exchange rate, but not all the way back to the original level. In this way, Mexico would lower both net exports and investment part way in order to get back to the natural level of output.

While there have been some complaints from emerging markets about how much US policy can negatively affect their growth and progress, Augustín Carstens has said that “there are limits to international policy-making coordination. Developing-economy leaders ‘should take policies in advanced economies as given’ and should ‘deal with their own problems’ through their own powers.”

In saying this, it seems that Carstens maintains a positive view that Mexico has reached a point where they have enough power that they can truly handle their own issues as they come along from movements in the US. This is obviously a good thing for both Mexico and the US, as the United States can make changes as they see fit (as we should) and Mexico will be able to respond accordingly.

Citigroup Hits Another Snag

Going into this week holding option positions in the financial sector I assumed this afternoon would be an interesting one as the Federal Reserve released its latest findings from their stress tests which take a closer look at how both commercial and investment banks would be able to continue their business practices in the event of a severe economic turn down. These tests have been big deals in the investment communities during the last couple of years especially because as economic conditions have improved and banks capital and leverage ratios have followed suit, they have raised dividends and buy back programs. (Obviously investors love this)

After the market closed today the FED released the results of the tests and all notables but one passed; Citigroup was that one. This botched capital plan and stress test is just the latest of some surprising mistakes for the bank. At the end of February Citigroup announced that they would be taking around a $400mm loss from their lending arm in Mexico due to some accounting gaps. The Mexican company Oceanographia was a government contractor that had stopped doing business with the government, but obviously this did not stop Citigroup from continuing to lend to them to the tune of $400mm that could not be repaid and went down as a loss on earnings that already missed last quarter. (WSJ)

While the details of what exactly the proposal was that was rejected by the FED this year, investors have reason to be concerned I think, as this is the second year in a row that the FED has rejected the banks capital redistribution plans and when added to their recent issues in Mexico and with earnings make one wonder what exactly they are doing to lag behind the rest of the big name banks. Due to this rejection, Citi will also not be able to make any changes to their capital redistribution program until next year! (WSJ) The stock traded as far as 6% down in the after hours market, and I fully expect it to trade around there tomorrow.

The stock itself is the most glaringly undervalued of all of the big name banks and has been cited as a top investment idea for 2014 by numerous voices in the industry, but with stories like these recently, investors are being shown why the stock commands the valuation that it does. I think that Citigroup could be hurt badly this upcoming quarter by the weakness in the emerging markets as well as continued weakness in fixed income trading as well (part of the reason they missed last quarter). I also think that Citi is being made a bit of an example of by the FED in an attempt to show that their programs have some sort of bite to them. For now, I would absolutely stay away from Citigroup unless I was taking it for a quick trade, otherwise the executive board of the company needs to show that they have things under control and have the FED jump on board too; until then the stock remains a “what could be” story.

The Economic Costs of Mexico’s War on Drugs

Earlier this week, online rumors surfaced about a raid on a Mexican drug cartel member’s home where $22 billion in cash was found, as well as exotic animals, an underground hot tub, and millions of dollars of stolen art. This news was perpetuated today as the Mexican government announced that it was successful in its Navy-marine raid of capturing Joaquin “El Chapo” Guzman, Mexico’s most notorious drug cartel leader. The billionaire cartel leader is famous for his storied rise from peasant farmer to head of the famous Sinaloa cartel. Many believe that the capture of El Chapo is huge news for Mexican President Enrique Pena Nieto of the PRI Party. The PRI party had long ruled Mexico until it lost power in 2000. Many criticize the party for its policies in the 1980s and 1990s that cemented drug cartels into the fabric of Mexico.

The successful capture of El Chapo signaled to many analysts the success of President Nieto’s anti-cartel efforts. Despite this, many citizens are still skeptical. Jose Careano, a 35 year old office worker responded to the news of the capture of El Chapo by saying, “They finally got him? It would be good for the country, but kind of doubt it. And if they have got him, they’ll let him go away. He’s untouchable.” (WSJ – Mexico’s Most Wanted Drug Lord Captured) The skepticism regarding the capture of El Chapo comes from previous occurrences where El Chapo was either captured and released by corrupt officials or barely escaped as military raids were suspiciously delayed by hours or days. This as well as El Chapo’s successful escape from a high security prison in a laundry cart make many Mexican citizens believe that he is untouchable.

Only time will tell if the capture of El Chapo proves to actually be a success, but what we do know is that the violence brought on by El Chapo and other cartel leaders has had grave economic costs on the Mexican economy. Violence in Mexico, has increased since the Felipe Calderon administration declared war on drug cartels. In 2011, there was over 50,000 drug related deaths in Mexico. The increased violence and uncertainty in the stability of the country has led to many businesses halting or pulling out investments.

In 2011, Mexico’s GDP grew at a rate of 1.84%, which was the lowest growth in over 20 years. It is hard to state the direct effects that the violence had on Mexico’s economy because 2011 was in the midst of a global recession. Despite the confounding variables, a study conducted by the World Bank stated that a reduction of 10 homicides per 100,000 produces an increase in GDP per capita between 0.7% and 2.9%. Another study showed that in 2000 violence in Latin America contributed to an overall loss of 14.2% of the regional GDP. Furthermore, an instrumental variable regression analysis conducted by Stanford showed that the increase in violence in Mexico contributed to a small decrease in average labor income and a decline in small business revenue. (Stanford – The Economic Consequences of Drug Trafficking Violence in Mexico) With all of this data, we can state the violence in Mexico has had profound impacts on Mexico’s economy. The successful capture of El Chapo would show that Mexico’s effort on the war on drugs is becoming more effective, and as shown by the data from multiple studies less cartel violence will ultimately lead to a more successful Mexican economy.