Mexico outlook hinges on U.S.

Economic slowdown in Mexico could be a major drag on the Latin region as a whole in 2007. Economists point to weaker manufacturing and slower economic growth in the U.S. as the main culprit roughly 90 percent of Mexico’s industrial exports, including automobiles, auto parts, and electronics, head to the U.S.

Coutino forecasts a significant drop in Mexican GDP, from 4.5 percent in 2006 to 2.0 percent in 2007. Bertrand Delgado, economist at Ideaglobal, predicts a retreat to 3.5 percent in 2007, while BNP Paribas’s Dela Fuente forecasts a 2.8 percent reading for Mexico in 2007 if the U.S. economy itself suffers a “hard landing.”

However, Dela Fuente says the global markets are currently pricing in a “goldilocks scenario” in which a U.S. slowdown fails to derail global growth. If a hard landing does occur (e.g., per BNP’s 1.6-percent U.S. GDP forecast), that, in turn, could affect both Latin and Asian growth.

“We see the U.S. slowing very sharply,” says Dela Fuente. “It is our opinion the U.S. will face a hard landing.”

“[The slowdown in] U.S. manufacturing and housing sectors will eventually impact U.S. employment and consumption,” he adds. “If the U.S. faces a hard landing and Asia and Europe can’t pick up the baton, what happens to commodity export prices? Latin America would be very vulnerable.”

Mexico is also vulnerable to a continuing slide in crude oil prices. While front-month crude oil futures prices blasted steadily higher for a good portion of the past four years, prices collapsed after July 2006. Nearby crude plunged from roughly $78 per barrel to nearly $50 per barrel in January 2007. Crude oil represents roughly 15 percent of Mexico’s total exports, and equals about 35 percent of the fiscal revenues for the Mexican government via the state- controlled oil company, Pemex.

“If crude oil goes below the $50 to $45 range and stays there for a long period of time, the Mexicans will have some revenue constraints,” Ideaglobal’s Delgado says. “A $1 decline in oil represents about $900 million in revenues.”

What does this mean for the peso?

“It will get hit because we believe the U.S. slowdown will come via manufacturing and oil prices coming off,” Dela Fuente says.

According to Delgado, the U.S. dollar/ Mexican peso rate (USD/MXN), currently trading around 10.94, will come under pressure from these factors and potentially move toward 11.14 by the end of 2007.