Mexican Oil and the 2014 budget

In the last months, we have experienced a collapse in the K factor (figure 1), something that has driven the price of the Mexican crude mix near to the lows we saw during the summer of 2012 (figure 2). 

The collapse in the K is a result of the fall in prices of crudes with similar grades that are trading in multi-year low levels and that compete with the MAYA crude in the gulf coast (for instance, Canadian Crudes, figure 3). 

The problem with this is that the 2014 budget assumes an average price of 85 dollars per barrel, when the Mexican mix is currently trading just below the $90 mark. What make it worse, is that the K factor has been revised to around -7 this week, (-1.5 compared to last month), being this K the one that will be in place from December first until the last day of the month. So, caeteris paribus, the Mexican mix at the beginning of December will be 1.5 dollars lower. Even if the K should be revised higher in the future, a sharp fall in the price of crudes globally could put pressure on Mexico's public finance. Moreover, if this scenario does not materialize, it is highly probable that the average price of the Mexican mix will be very close to the budget's assumption, leaving no extra revenues for the following fiscal year.

US Beveridge curve

The Beveridge Curve, known as the line that relates unemployment and the job vacancy rates, has shifted upwards since 2010. What this means (and as we can see in the chart below), is that for any level of unemployment rate we now should expect a vacancy rate 0.5% greater than it used to be before the crisis.

What can be read from this move, is that unemployment has a bigger structural component compared with the market that we used to know in the pre-crisis world; i.e. the inefficiency in labor market is now greater given the mismatch between the openings and the people who are out there ready to get hired. From a policy maker perspective, this could mean that monetary policy has done most of the job it could have done, and that tapering may not be as bad as some people might think.

What markets should be wondering

Since the second quarter of this year, markets haven been speculating whether tapering will happen in September, October or any other month, and all the surveys are based on this discussion. Even if that is an important question, what we know is that the FED will be very cautious about the speed of tapering, so maybe the relevant question is how fast the FED is going to slow the pace at which they buy treasuries and MBS in the market, and how much time it will take to normalize the monetary stance. When QE1 and QE2 were announced, we knew in advance the beginning and the end of them, this time around we do not. What matters as well are the tweaks that the FED could do to its language, specially in its forward guidance (change in thresholds).

Probably the FED will taper in September, and not because they are very happy with the evolution of the economy. They will taper because even if inflation is running below historical standards, inflation in financial assets seems to be excessive in some cases,  as reflected in the last few months in the sell-off of some financial assets, such as gold, high yield currencies, EM assets, etc. They want to have enough time so the markets can digest the withdrawal of stimulus that eventually will come, but at the same time, they can not afford any policy mistake and they will try to smooth the transition to tighter monetary standards. The recovery in the US seems to be robust enough to be sustained, but at the same time, the global economy has suffered some structural changes that will not allow this recovery to be as fast as we would wish.

In terms of trading, my favorite strategy would be to take advantage of this environment where volatility and correlations are low but at the same time valuations seems to be still stretched in a variety of assets. Differentiation and relative value should continue to pay in the next few years.