The lessons from Mexico’s ‘strange’ problem with Trump

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Martin Currie Investment Management, a long-time investor in Mexico through its emerging markets strategies, believes the latest bright spot in the battle with the US Trump administration, may not last long.

According to Kim Catechis, the firm’s head of emerging markets, the relief seen last week, when markets recovered after Mexico strengthened its border controls at the US behest, “is going to be ephemeral”.

He said in his latest not to clients: “Not to be a party-killer, but I’m afraid any relief is going to be ephemeral. The real investment lessons from this strange episode are these:

  1. This move is evidence for those who haven’t noticed that trade has become a weapon to be used for political and other ends – by weaponizing trade, it has become politicised. This politicisation of trade by Washington has set a new precedent of ignoring one’s own international commitments. USMCA (the new version of NAFTA) was signed by the presidents of Canada, Mexico and the US on November 30, 2018, barely six months before this new tariff threat.
  2. If Mexico, a signatory presenting the agreement for consideration by its Lower House on May 30, can be hit by extra tariffs, then what is the point of signing any trade agreement with the US? Trading with the US will now carry a significant risk premium, because no country can be sure that when they sign a deal with the US it will be final.
  3. For corporations that are active in North America, this is an unwelcome dose of extra uncertainty. This is important, because it will result in a delay or a freeze in capex deployment, as boards try to quantify the risks they are running by operating in this geography. It will not only affect Mexican firms, or American or Canadian firms that have installations in Mexico or whose suppliers are based in Mexico. It will affect Japanese, Taiwanese, Korean and German firms who operate assembly plants, service, repair and logistics centres for autos, servers, televisions, desktops and parts.
  4. Tariffs will become permanent, directly eroding company profit margins and hurting investment returns. Supply chains are disfigured and costs at every stage will go up, with consumers paying the price. Cost of trade credit and insurance will rise, further hurting profitability. And naturally, new, heightened uncertainty permeates every level of corporate decision making, reducing returns for investors and narrowing the options for company management.”

Catechis said there would be a higher risk premium attached to trading with the US. “The US is still a highly desirable destination market, but its attractions now come with a nasty lack of clarity and a faltering belief in the reliability of the terms of agreements. Normally, if you’re a foreign company selling your goods into a market like that, you take great care to avoid alignment with the regime’s enemies, whether real or apparent. You also are much more tentative when you think of deploying capital to invest in that country. So, a feasibility plan to build a new factory in country ‘A’ versus country ‘B’ would carry a built-in economic return hurdle that is significantly higher in the case of the country with perceived higher policy risk. Then there’s the ‘collateral damage’ of Korean, Taiwanese and Japanese companies, servicing their US clients from Mexico – they may be forced to service them from their EU plants, switching Mexican production to the EU.

“If you’re a foreign government thinking about an invitation to sit down and negotiate a trade deal with the US today, one of the preoccupations will inevitably be around the legacy of this deal – will you be able to ‘sell’ it to your legislative chambers? Will the US grind you down during the negotiations? Will you then be able to relax thinking that a marginally suboptimal deal is still better than a seriously bad deal? Or will the US come back in six months’ time and unilaterally try to extract a higher price? So, I think you get inaction and stalling for a time. Some will stall hoping for a Democrat President in 2020. They may be disappointed, because in many instances, the Democrats have aligned with the Republicans, at least where China is concerned.”

– G.B.

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