Mexico gets ready for a delicate dance

Investors are about to find out just how Mexican President-elect Claudia Sheinbaum plans to govern, with the country’s first female leader set to begin her term next week. Amid rising uncertainty being driven by a controversial reform to the country’s judiciary that was championed by current President Andrés Manuel López Obrador in his final months, just how the changes will affect Mexico’s trading relationship with the rest of North America has made markets nervous.
“Sheinbaum has a generational opportunity to transform Mexico…but I also think the risk really is probably as significant as the opportunity,” Kimberly Breier—a senior advisor at Covington & Burling and former US diplomat—said in a recent panel discussion hosted by the Council of the Americas, referring to the reform which shifts political control over the judiciary and raises concerns about its independence. The move could potentially require the massive United States–Mexico–Canada trade agreement to be renegotiated. “There is no question in my mind that this package of reforms runs counter, at least to the spirit of USMCA, if not to the letter of it,” Breier said.
As Breier sees it, the reforms have already started a renegotiation of the USMCA that the next US President will have to deal with when they take office in January, and the market has not been favorable to the uncertainty that entails. The peso (USD/MXN), which immediately fell 4% against the US dollar after Sheinbaum’s win, declined another 8% over the past three months and is hovering near a two-year low. The iShares MSCI Mexico ETF (NYSE: EWW), which follows a broad-based index of Mexican equities, has declined 15% since Sheinbaum’s election. The S&P 500, which tracks the biggest stocks north of the border, rose 8% over the same period.
Outside of the coming drama set to unfold over the USMCA, analysts have been expecting Sheinbaum—an energy scientist by training—to largely toe the line set by López Obrador, her longtime mentor who has clashed with the country’s business community. He’ll continue to loom large, controlling the Morena movement that dominates the country’s legislature. Some believe Sheinbaum will gradually forge a more pragmatic path, pointing to her success as Mexico City’s mayor, where she governed more as a technician than an ideologue like her predecessor.
“She’s focused on getting things done in her government, whereas López Obrador’s focus was almost exclusively on breaking the back of the opposition,” Pamela Starr, a professor at the University of Southern California, told the Council of the Americas panel, noting that López Obrador had already outlined an agenda for Sheinbaum’s first year in government. The new president will likely be limited in what she can do initially and won’t be able to cross any red lines laid out by López Obrador.
Still, Starr expects Mexico’s new president will be able make progress on the energy front, and that could be good news for some of the biggest companies involved in the sector including Enel S.p.A. (CBOE: ENEL), Iberdrola (CBOE: IBE), Vive Energia, Acciona (CBOE: ANA) and Sempra Energy (NYSE: SRE).
“Sheinbaum is an energy nationalist. That’s not going to change in Mexico, but there’s a lot of daylight between what she wants to do with energy policy and what López Obrador did with energy policy,” Starr said. “I think she’s likely to encourage private investment, both in clean energy generation but also in self-supply…She’s also going to need to invest in transmission. She’s recognized that she has no budget to do it, so she’ll probably turn to public private partnerships to achieve that.”
José Antonio Meade, a former Secretary of Foreign Affairs for Mexico and current HSBC board member, painted a more nuanced picture of the path Sheinbaum might take her administration down and argued that there are structural factors that may work to the country’s long-term favor despite the short-term uncertainty. He said the country’s exports had been growing long before the nearshoring boom accelerated as the US sought to bring supply chains closer to home.
“I think that we have the narrative backwards,” he said at the Council of the Americas event. “It is not that Mexico is going to grow because of nearshoring. It is because Mexico grew that nearshoring is a real possibility.”
Meade also said all the nearshoring activity that had increased demand for electricity could lead to attractive opportunities in both generation and transmission if Sheinbaum can articulate clear rules of the game. He argued that anyone worried about possible renegotiation of the USMCA agreement should remember that Mexico is not going to go anywhere.
“We tend to think about the USMCA as a negotiation between Mexico and the US. And really USMCA, because of the way that that trade has evolved, is a negotiation between Mexico and the US and the structure of the value chains, which are North American in essence,” he said. “If Mexico were to disappear tomorrow, there’s 20 value chains where chaos would make itself present. The world would literally stop if Mexico were not part of the equation.”
Mexico, in other words, is too big to fail, and the US will have no choice but to sit down and work out a deal. That could be good news for the country’s equities and currency, which may have found a bottom. Sheinbaum, meanwhile, has sent some signals that may not yet have been fully appreciated by people worried about the transition, according to Breier.
“You’ve got to give the president-elect a chance,” Breier said. “This is a woman who has governed a city whose population and economy is larger than that of many countries, and so she’s obviously a very capable person. She’s a very talented person…Looking at the data that we have, which is her track record in the city and her picks for the cabinet, I think we need to give her a chance.”
Mexico’s markets have been reacting to concerns about the judicial reform, but some of the potential downsides may already be priced in. As Sheinbaum prepares to take the reins on Oct. 1, the highly integrated supply chains that already connect the country with broader North America will act as a force of stability. That all means that Mexico could be a deal right now.