Mexico’s 2024 Election: Navigating Reforms, Risks, and Opportunities

• Reform risks: Constitutional and judicial reforms may increase fiscal pressure and reduce institutional checks.

• Economic outlook: Expect a cyclical downturn and complications in monetary policy due to restrictive rates and depreciation of the peso.

• Investor confidence: Key appointments and fiscal discipline commitments could stabilize the market.

• Investment strategies: We see opportunities amid spread widening in sovereign bonds and corporate sectors.

The outlook for Mexico’s financial markets remains uncertain as the nation begins the transition from President Andrés Manuel López Obrador (AMLO), a member of the left-wing National Regeneration Movement (Morena) party, to his successor, president-elect Claudia Sheinbaum, fellow Morena member and most recently head of government of Mexico City. With looming constitutional and judicial reforms, investors must stay vigilant. Here’s what to expect and how to navigate the shifting landscape.

A new era of reforms: risks and realities

We are more cautious on Mexico sovereign and corporate debt given the lack of visibility into the country’s reform agenda. We see risks that constitutional reforms expected to pass in September could both increase and entrench social and fiscal commitments but without tapping new funding sources, putting the fiscal consolidation targeted for 2025 at risk.

In addition, the judicial reforms may politicize Mexico’s Supreme Court, which has previously rolled back certain policies introduced by AMLO that would negatively affect the private sector.

That said, given statements leading up to the election of Claudia Sheinbaum, we expect the environment for corporate debt to be similar to what existed under AMLO, and in some sectors her policies could be more supportive.

We are expecting some push-and-pull between AMLO and Sheinbaum as they take the opportunity to push through their reform agenda – AMLO in the final months before he leaves office and Sheinbaum as she rides the momentum of her landslide victory while also seeking to maintain campaign commitments and to ease market fears, which have been felt most keenly in the currency.

We are seeing the first test between AMLO and Sheinbaum with proposed judicial reforms: AMLO appears to want to pass judicial reforms as soon as possible, while Sheinbaum announced an open parliament to debate the reforms before their approval, inviting law bars, academics, and judicial branch workers to engage in discussion and increase understanding.

Here we discuss how these dynamics could affect public finances, the economy, investor confidence, and investment strategies in the coming months.

Public finances

Sheinbaum has announced that certain commitments made during her campaign will be part of her priority reforms. For instance, she plans to submit to Congress a bill establishing a universal scholarship for public school students from kindergarten through high school and a bill creating a pension for women aged 60-64 (i.e., before they qualify for the universal pension at the age of 65). These social/fiscal commitments would make the budget less flexible, especially if they are raised to a constitutional level, which would make them inherently more difficult to adjust afterward.

Considering these new potential expenditures, we are skeptical of Sheinbaum’s plan to achieve a fiscal deficit of 3.5% in 2025 from an expected deficit of 5.9%, considering that no fiscal reform is envisaged. This signals that the debt trajectory may not level off, but rather push even higher, toward 60% of GDP (from 55% currently) over the next two years – about 7 percentage points higher than the average for BBB rated sovereigns. This could put pressure on Mexico’s sovereign rating.

Election impacts on the economy

Typically, the economy accelerates before an election and then loses steam in the following months. We should see some government spending declines in investments and public procurements, which would mean the economy is already in a cyclical downswing.

In terms of monetary policy, the easing cycle has barely started, and real rates remain very restrictive. The central bank will likely look for only two more cuts, in September and December, though the sharp depreciation of the Mexican peso could complicate these moves.

Looking longer term, along with spending inertia, the government is facing mounting budgetary restraints after forfeiting a substantial part of its oil rent to Pemex. This could, for example, translate to lower investment in the electricity sector, and as such poses a downside risk for broad economic growth.

Investor confidence: awaiting key announcements

Investors are cautious as they await the timeline and details of judicial reform. Depending on what shape the reform takes, we could see a deterioration in Mexico’s institutional strength. The Supreme Court has rolled back some AMLO policies that hurt private companies, so a significant shift in the court could pose an important risk. Even with a simple majority in Congress, many reforms can be pushed through, including labor reform and reforms affecting banking, water usage, and mining. And if the judicial reform passes, there would be fewer checks and balances against potentially market-unfriendly reforms. These dynamics could keep markets on their toes during the next few years.

In the short term, we think investor confidence could be supported by a few recent and pending announcements. First, the Sheinbaum has already announced several new cabinet members which reflect her focus on professionalism and strong technical backgrounds, as well as continuity with the current administration’s policies , and we expect Rogelio Ramirez de la O will continue as Minister of Finance, and Sheinbaum appointed Elena González, an expert in sustainable development and government finance, as Secretary of Energy. We will also be closely watching developments around the heads of Pemex and CFE, the state-owned electric utility. The Minster of Interior will also be critical, since this position will be important for negotiating with Congress.

Leadership roles in the lower and upper houses of Congress also bear watching, with appointments that are closer with or more conciliatory toward Sheinbaum likely favorable.

In December Sheinbaum is expected to nominate her replacement for Banco de Mexico Deputy Governor Irene Espinosa. Sheinbaum has already spoken in favor of Banxico’s independence and has voiced her preference that another woman replace Espinosa, who has been the most hawkish member on Banxico’s board. We expect the new appointment to have the necessary credentials but nonetheless to be more aligned with the views of AMLO’s last three appointments. Still, the new governor is unlikely to create a different dynamic on Banxico’s board than what we’ve seen in the past couple of years.

Sheinbaum is also expected to nominate a judge to the Supreme Court to replace Luis Maria Aguilar. Assuming judicial reform does not come to pass, we see four possible members who are closely aligned with AMLO’s and Sheinbaum’s views. This new order at the court would likely make it difficult to deem a law unconstitutional and require companies to file separate injunctions into specific laws. We believe the Supreme Court will continue to serve as an important but less effective check-and-balance. By the end of her administration, she will have named three additional judges, which is why we believe independent and technical appointments are critical.

Also in December, Sheinbaum will be presenting her first federal budget for the year 2025. Thus far, she has reinforced her commitment to an austere and fiscally responsible government, working toward a deficit of 3.5%. The appointment of Minister of Finance Rogelio Ramirez de la O suggests continuity on that front. We believe a tax reform is less likely during the administration, given recent comments.

Investment strategies: opportunities amid uncertainty

Sovereign bonds

We have seen Mexican hard currency sovereign bonds widen around 20 bps since the election, which is close to pricing in a one-notch downgrade by Moody’s and S&P. Fitch is already at BBB-. But we remain cautious in the near term and await some relief from pending announcements expected from Sheinbaum and a potentially watered-down judicial reform which could reassure investors. Regarding sovereign bonds specifically, in a bid to reassure investors, the government recently called US$894 million of its outstanding notes due April 2025 as part of US$4 billion in refinancings it is carrying out. The government is also planning to refinance local debt coming due in the next year. These are one way to reduce volatility and make the transition smoother.

Corporate bonds

So far, we expect a similar overall environment for corporates that existed under AMLO. But the new superpowers and additional fiscal pressure from the new social commitments add some risks. We are cautious on banks, which could face additional taxation and also potential changes to operating rules, such as a cap on fees. We are still more cautious on other regulated sectors, such as utilities, especially if the CFE reform were to pass; this would amount to inserting the company in the energy ministry and severely reduce the scope for the private sector to participate in the industry. As a result, we have seen debt spreads for some of the private electricity companies widen around 30-40 bps. We now see some opportunities among Mexican corporates, particularly in sectors related to nearshoring and consumption for which we think the spread widening is unjustified.

With our extensive experience managing emerging market debt and our deep understanding of Mexico’s unique landscape, we believe we are well-positioned to unlock the potential of the evolving opportunities in Mexico. This dynamic environment demands a laser-focused, agile approach, and we are ready to navigate these complexities to maximize returns and mitigate risks.