Real Beats Mexican Peso as Growth Insulated From U.S. Slump: Brazil Credit

Bloomberg.com   |  September 8 2010 3:23 EDT

Brazil’s real is rising to a nine- month high versus the Mexican peso as surging foreign investment and domestic consumption shield Latin America’s largest economy from a slowdown in the U.S.

The real gained 9.7 percent against the peso from June 7 to Sept. 7, the biggest three-month gain since the period ending in March 2009, according to data compiled by Bloomberg.

Brazilian consumers are sparking the fastest expansion in the $1.6 trillion economy in 15 years and limiting the impact of slowing demand for commodity exports as global growth slackens. Brazil’s gross domestic product will expand 7.1 percent this year, compared with 4.7 percent in Mexico, which sends about 80 percent of its exports to the U.S., according to the median forecasts of economists surveyed by Bloomberg.

“Brazil has a strong, vibrant domestic economy, and the inflow situation on Brazil is by far better than the Mexico one,” said Flavia Cattan-Naslausky, emerging markets strategist at RBS Securities Inc. in Stamford, Connecticut. “Mexico is taking the brunt of the U.S. story. The domestic push has always been its Achilles’ heel.”

Foreign investors bought a net $29 billion of Brazilian bonds and stocks in the seven months through July, tripling the amount in the same period last year, according to the central bank. Petroleo Brasileiro SA, the country’s state-owned oil company, is preparing a share offering for this month that may total $32 billion.

‘Double-Dip’ Concern

“With initial public offerings and real money flows from investments, the situation in Brazil is very benign,” said Sergio Trigo Paz, who oversees about $4 billion of emerging- market debt at BNP Paribas Investment Partners in London. “In Mexico, you have fears of a double-dip in the U.S., and a change of perception in security. Brazil and Mexico are trading on their own individual stories.”

The real climbed 1 percent yesterday, the biggest gain in two months, to 7.565 pesos and touched a nine-month high of 7.579. The Brazilian currency declined 0.4 percent to 7.533 pesos at 10:35 a.m. New York time. The real is up 0.5 percent this year versus the peso after gaining 27 percent in 2009. One dollar buys 1.7236 reais and 12.9827 pesos.

Brazilian retail sales grew 11.3 percent in June from a year earlier, the fastest pace since March. Private consumption accounts for 61 percent of Brazil’s economy while exports make up 11 percent.

Drug Violence

In Mexico, exports dropped to a five-month low of $23.3 billion in July as demand from the U.S. faltered. The unemployment rate in the world’s biggest economy rose to a three-month high of 9.6 percent in August while sales of new homes slumped in July to the lowest level on record. The U.S. economy grew at an annual rate of 1.6 percent in the second quarter, slowing from 3.7 percent in the first three months of the year.

Drug-related violence in Mexico is also shaving 1.2 percentage points off growth per year in Latin America’s second- largest economy, Finance Minister Ernesto Cordero said on Sept. 1.

The real’s outperformance in the past three months marks a reversal from earlier this year, when the peso rallied as the U.S. emerged from recession. The Mexican currency gained 8.1 percent versus the real during the first three months of the year, the most since September 2008. The peso rose 1.2 percent versus the real on Sept. 3, the most since June, as a U.S. government report showed private payrolls climbed in August more than economists forecast.

Yield Gap

The extra yield investors demand to own Brazilian government dollar-bonds instead of U.S. Treasuries fell 34 basis points, or 0.34 percentage point, since June 8 to 217 today, according to JPMorgan Chase & Co. indexes. It was 56 basis points higher than Mexico’s, near the smallest gap since July 30.

In the credit default swaps market, the risk of non-payment for Mexican bonds rose above Brazil’s to the highest level this year. The cost of protecting Brazilian bonds against default for five years dropped 24 basis points in the past three months to 123 yesterday, or 17 below that of Mexico, according to CMA DataVision prices. The gap reached 18 on Sept. 1, the biggest gap since December.

Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a government or company fail to adhere to its debt agreements.

Brazil’s BBB- credit rating from Standard & Poor’s is the lowest investment grade and is one step below Mexico. Moody’s rates Brazil Baa3, two notches below Mexico.

China Ties

Option traders are the most bearish on the peso versus the real since April 2009. One-month options giving investors the right to sell the peso cost 3.7 percentage points more than contracts to buy today, compared with 3.1 percentage points for Brazil’s real, according to data compiled by Bloomberg. Two months ago, it cost more to buy protection against a slide in the real.

Brazil is also benefiting from its growing ties with China, which overtook the U.S. as the South American country’s biggest trading partner last year, said BNP’s Trigo Paz. China, which is posting annual economic growth of more than 10 percent, accounts for 16 percent of Brazil’s exports and less than 2 percent of Mexico’s.

“Brazil is sharing growth with Asia,” Trigo Paz said. “Their export base is more diversified.”