FxWirePro: Japanese debt fund yields up for roller coaster ride on feeble Mexican peso – No “RORO” in LatAm sovereign debt

The JGB curve bull flattened this week as market sentiment turned positive in the wake of the 20y auction on last Thursday.

Mexico is becoming a favored destination for yield-hungry Japanese investors as the peso’s unprecedented weakness boosts the allure of the Latin American nation’s bonds.

Daiwa SB Investments Ltd. has seen assets of its two Mexican debt funds jump about 13 percent to 41.2 billion yen ($361 million) in February, according to information on its website. The funds received a net 8.1 billion yen in six months through Jan. 31. The firm, which oversees about $48 billion, is enjoying a surge in demand from Japanese clients searching for yield who view the Mexican currency as a bargain given the battering it took after U.S. President Donald Trump’s election win, said Kenichiro Ikezawa, a Tokyo-based senior fund manager.

“When it comes to emerging markets, the worst time is the best time to build positions,” Ikezawa said. “Some Japanese investors benefited from this strategy in Brazil and South Africa and now they are looking at who could be next.”

How Japanese investors suffered from bets in high-yield funds:

The two vehicles, nicknamed Amigo funds, invest solely in the Latin American nation’s sovereign debt. They’ve returned 4.9 percent in the past month as the peso rebounded from its record low in January, according to Daiwa SB. That compares with a 1 percent gain in the Bloomberg Mexico Local Sovereign Bond Index last month.

Now you may arrive with a question, what is your strategy to cope with volatile Mexican assets?

The peso’s direction is solely up to Trump’s policies and his comments at this moment, while the next key event is the renegotiation of Nafta - the North American Free Trade Agreement. The main scenario is that the renegotiation will be quite benign and they may agree to update some of the details of the 20-year-old agreement while keeping its framework. That type of outcome could trigger a sharp rebound in the peso.

When the peso strengthens, the local sovereign bonds tend to rally. Therefore, we typically extend duration when the peso’s outlook is bullish. We are neutral now because it’s too risky to bet on either side of the scenario, which keeps us on a cautious stance.