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RR RUEHCD RUEHGD RUEHHO RUEHMC RUEHNG RUEHNL RUEHRD RUEHRS RUEHTM
DE RUEHME #3136/01 1582012
ZNR UUUUU ZZH
R 072012Z JUN 06
FM AMEMBASSY MEXICO
TO RUEHC/SECSTATE WASHDC 1487
INFO RUEHXC/ALL US CONSULATES IN MEXICO COLLECTIVE
RUCPDOC/DEPT OF COMMERCE WASHDC
RUEATRS/DEPT OF TREASURY WASHDC

UNCLAS SECTION 01 OF 02 MEXICO 003136 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
FOR WHA/MEX AND EB/IFD/OMA 
USDOC FOR 4320/ITA/MAC/WH/ONAFTA/ARUDMAN 
TREASURY FOR IA - DAVID BECKWORTH 
 
E.O. 12958: N/A 
TAGS: ECON EFIN MX
SUBJECT: VOLATILITY IN MEXICAN FINANCIAL MARKETS 
 
 
CORRECTED COPY - PLEASE DETROY ALL COPIES OF MEXICO 3135 
 
Sensitive but Unclassified, Entire text. 
 
¶1. (SBU) Summary: During the week of May 29 econoffs and FSN 
ECON specialist talked with a broad range of analysts and 
economists from foreign banks and the Mexican Stock Market. 
Their reading was that the recent volatility in Mexican 
financial markets was directly tied to capital flight from 
emerging markets to safer markets paying higher interest 
rates.  But, as presidential elections draw near, the 
political factor has begun to play a role.  Political 
uncertainty and fear of a victory of the Democratic 
Revolutionary Party's candidate, Andres Manuel Lopez Obrador 
(AMLO), have led a few sophisticated investors to begin 
taking precautions, shortening long-term positions and moving 
assets out of the country.  Nonetheless, most sources report 
that Mexican economic fundamentals including a flexible 
exchange rate, large inflows of crude oil revenues and 
remittances, low interest rates, solid public finances, 
strong financial institutions, and prepaid foreign debt 
remain robust.  End Summary. 
 
HIGHER INFLATIONARY EXPECTATIONS AND INTEREST RATES 
--------------------------------------------- ------ 
 
¶2. (SBU) During the past couple of months, jitteriness has 
been seen in emerging financial markets, including Mexico. 
Inflationary risks and the fear of higher interest rates in 
the U.S., Europe and Japan leading to a global economic 
slowdown have shaken stock markets and foreign currencies 
worldwide.  During the past three years, with excessive 
liquidity worldwide, investors poured money into emerging 
markets to capture higher interest rates.  But, after hikes 
in commodities prices and expectations of a tighter monetary 
policy by the Federal Reserve, fund managers began shifting 
money out of high-risk markets to more secure investments, 
like U.S. Treasury bonds. 
 
¶3. (SBU) All the analysts we polled indicated that the recent 
capital flight seen in Mexico was the result of the reduced 
spread between Mexican and U.S interest rates, currently at 
200 bps.  As Mexico's country-risk has increased from a 
record low of 94 bps in March to 145 bps the last week of 
May, local funds' strategy during the past month has been to 
shorten long-term positions (10-year M Bonds).  Local 
investors are lowering their risk profile because of the 
fewer portfolio diversification options they have compared to 
foreign investors.  From April to the last week of May, 
approximately MP 9.4 billion (USD 840 million) in Mexican 
government bonds held by foreign investors left the country. 
For years, foreign investors have stayed in the long end of 
the curve, but they could decide to close these long-term 
positions if their perception of Mexico's political 
environment worsens.  An optimistic Edgar Camargo, chief 
economist of Bank of America in Mexico, told us that he 
doesn't expect further foreign capital flight, at least not 
more than USD 500 million. 
 
STOCK MARKET FALLS 10.5% IN MAY 
------------------------------- 
 
¶4. (SBU) The IPC, the Mexican Stock Market's main index, fell 
10.5% in May.  After hitting a record of 21,822 on May 9, the 
IPC dropped to 18,677 at the end of the month.  Alejandro 
Reynoso, Deputy Director and Chief Economist of the Mexican 
Stock Market, and the most pessimistic of the economists with 
whom we spoke, explained that this volatility was the result 
of external and domestic factors. He agreed that capital was 
leaving Mexico principally as a result of expected higher 
interest abroad.  Domestically, he added that changes in 
regulations effective in 2005, had lifted restrictions on 
pension fund investment in foreign assets.  To date, Siefores 
(Specialized Retirement Investment Societies) have invested 
between USD 3 and 3.5 billion in foreign securities.  He 
noted that this was equivalent to inward foreign direct 
investment over the same period. 
 
SOPHISTICATED INVESTORS CONSIDER PRECAUTIONS 
-------------------------------------------- 
 
¶5. (SBU) Reynoso added the uncertainty about the upcoming 
elections, the tie between frontrunners National Action Party 
candidate Felipe Calderon and Revolutionary Democratic Party 
candidate AMLO, miners and teachers unions' conflicts 
throughout Mexico, and a recent shooting at a car with Carlos 
 
MEXICO 00003136  002 OF 002 
 
 
Ahumada's family inside (Ahumada is a businessman 
incarcerated after videos of him bribing PRD politicians were 
made public), have not gone unnoticed by investors.  As 
evidence that a few sophisticated investors were growing 
concerned by political developments, Reynoso described a 
Siefore that had just pulled USD 80 million from the domestic 
market to buy S&P 500 index securities in an expensive 
transaction with an exchange rate as high as MP 11.36 to the 
dollar.  This Siefore expected the exchange rate to climb up 
to MP 12.00.  In a second case, one hedge fund manager called 
Reynoso after the June 6 morning shooting telling him that 
the fund would shorten its positions in Mexican securities. 
Reynoso is also seeing in increase in transfers of locally 
acquired foreign securities to U.S. banks from their branches 
in Mexico.  More than a fraudulent scam, since these 
transfers are not reported to tax or money laundering 
authorities, Reynoso sees it as a precaution against the 
possibility of less market-friendly policies should AMLO win 
the election.  Reynoso personally believed the chance of 
unrest arising from the election leading to a precipitous 
fall in Mexican markets was low, but the magnitude of such a 
politically driven fall would be significant enough that the 
most sophisticated domestic and foreign investors were taking 
limited defensive measures. 
 
MARKETS' REACTION TO DIFFERENT POLITICAL SCENARIOS 
--------------------------------------------- ----- 
 
¶6. (SBU) All analysts agreed the most positive scenario for 
financial markets is a victory of the rightist candidate 
Felipe Calderon by a large margin.  Markets would rise and 
investors would be more relaxed.  The worst scenario would be 
if AMLO wins but fails to announce his economic team quickly 
(Note: Reynoso mentioned Javier Beristain, former finance 
secretary during PRD Cuauhtemoc Cardenas' tenure as Mexico 
 
SIPDIS 
City Mayor as a good candidate to become Secretary of 
Hacienda).  If the Federal Electoral Institute is unable to 
announce a winner the week of July 3, pressure on local 
financial markets will also increase.  If Calderon wins by a 
tight margin, AMLO could take his supporters out on the 
street alleging fraudulent elections.  Still, analysts don't 
expect these demonstrations to last.  Reynoso felt the IPC 
could fall 15% and the peso could depreciate as much as 10% 
if AMLO continues to promote an environment of uncertainty 
over what his economic intentions would be as President. 
 
¶7. (SBU) Comment: In a scenario of a shrinking money supply, 
risk aversion to emerging markets, and worldwide portfolio 
adjustments, Mexico needs a solid and stable economic policy 
to successfully compete against other emerging markets in 
attracting investments.  The uncertainty of the electoral 
process' outcome remains a latent risk for the stability of 
local financial markets.  There is some anecdotal evidence 
that local and foreign investors have reduced their Mexican 
exposure and there is a chance for more rebalancing if the 
political environment deteriorates before and after July 2. 
Despite the difficult and uncertain electoral process, the 
majority of analysts and government authorities are confident 
in Mexico's sound economic variables: a flexible exchange 
rate, large inflows of crude oil revenues and remittances, 
low interest rates, solid public finances, strong financial 
institutions, and prepaid foreign debt, which will absorb any 
volatility shocks.  End comment. 
 
 
Visit Mexico City's Classified Web Site at 
http://www.state.sgov.gov/p/wha/mexicocity 
 
GARZA