The government may slow the pace of constitutional changes, but much of the agenda will ultimately be pursued. Investor concerns regarding the country’s institutions risk stymieing potential gains from nearshoring.

Having entered office only earlier this month, Sheinbaum is faced with a variety of challenges: the difficult macroeconomic backdrop she inherited from her predecessor, Andrés Manuel López Obrador (AMLO), and investor scrutiny regarding the implementation of the former president’s reform agenda.

Mexico’s peso and equities have underperformed since June’s general elections, when a landslide victory for the incumbent Morena party strengthened its legislative capabilities (Chart 1).

The scope for a meaningful recovery for these assets before the US election is limited, with prospects for 2025 dependent on sentiment regarding domestic policies and the outcome of the US presidential election.

AMLO’s agenda to remain with Sheinbaum

In September, Mexico’s upper and lower houses approved López Obrador’s constitutional amendment regarding the appointment of judges, and we expect that Sheinbaum will gradually push ahead with other contentious changes. The reform will see judges at various levels, including the Supreme Court, elected by popular vote in June 2025. This contrasts with the established qualifications-based system of selection. The executive and Congress, both controlled by Morena, will select most judicial candidates and members of a new disciplinary tribunal for judges.

These changes have triggered worries that judges’ rulings may overly favor the government and state enterprises, potentially eroding the business environment. Markets are also cautious regarding other proposed reforms, most notably plans to eliminate independent regulators in a range of sectors, including energy and telecommunications.

Removing objective regulators and potentially weakening the judicial system would make Mexico less attractive to foreign investors. This would compound longstanding structural limitations on investment caused by infrastructural shortcomings and energy sector inefficiencies.

Unless foreign enterprises can also seek arbitration for disputes in international courts, this could threaten potential nearshoring gains over the coming years. Moreover, eliminating independent regulators would risk a breach of the United States-Mexico-Canada Agreement (USMCA), which is up for review in 2026.

Political room for maneuver will be limited

We expect Sheinbaum’s presidency to prove challenging as she faces party pressure to enact reforms and external pressure to avoid eroding democratic processes. Moreover, plans to consolidate Mexico’s fiscal deficit while introducing more social welfare programs will be difficult amid sluggish economic growth.

Markets could play a moderating role. Sheinbaum could (in theory) slow, temporarily pause or temper the magnitude of the reforms to bolster sentiment. A potential adverse shock for Mexican assets following a Trump victory could motivate greater caution for the government. However, Sheinbaum has endorsed her predecessor’s judicial reform and has – although stating intentions to rein in total expenditure – outlined her objectives of furthering social spending in certain areas after López Obrador’s 2024 increases.

A combination of factors will motivate Sheinbaum to implement key parts of his broader proposals over the first half of her presidency (i.e. within the first three years of a single six-year term).

Is nearshoring faltering?

Morena’s reforms, alongside the risks that a second Trump presidency does more than ‘review’ the USMCA, have left many to question whether nearshoring will ever truly occur on a large scale. The Wall Street Journal recently reported that companies may be holding off on $35 billion worth of investment for these two reasons.

Mexico at least remains well placed to gain from a deterioration in relations between the US and China. US policymakers’ increased focus on national security and supply-chain resilience incentivizes businesses to move manufacturing. With integration into US supply chains, favorable market access within the USMCA, and lower labor costs, Mexico can still benefit regardless of who holds the Oval Office.

Some of the concerns may reflect a recalibration of excessive optimism about the immediacy of change. Judging nearshoring would always be hard to discern conclusively in real time.

Foreign direct investment (FDI) inflows remain somewhat uninspiring. Indeed, Banxico data show that the “new” FDI inflows, which surged over 2022, have since fallen below their pre-pandemic levels (Chart 2).

That said, a marked rise in gross fixed capital formation (GFCF) – particularly non-residential construction – still points to expanding manufacturing capacity and ancillary infrastructure, even if a large proportion of this can be attributed to recent public projects (Chart 3).

And, while the extent of the decline in new FDI has been surprising, it may not ultimately matter whether business expansion takes place via firms with existing operations or via new entrants.

USMCA: Reviewed or ripped up?

Mexico’s reforms will be a source of contention during the 2026 USMCA review.

A Harris administration may focus on the provision within USMCA for independent judges to preside over labor disputes but is unlikely to seek major changes to the USMCA overall.

However, a Trump administration may use the review to extract other concessions, for example, on migration and border security. Threats of renegotiation rather than a review, combined with a stronger push to onshore rather than nearshore manufacturing, could hold back corporate investment and damage market sentiment. That said, it is not clear that ripping up the USMCA – or changing it to reverse the tailwinds to Mexican manufacturing – is plausible.

Renegotiation would require congressional approval in the US and parliamentary agreement in Canada. US corporations own substantial manufacturing operations in Mexico, which could be severely damaged. Finally, the US arguably needs Mexico more than ever if Trump is serious about launching a second trade war and decoupling from China (Chart 4).

Muted economic momentum is a challenge for fiscal consolidation

Alongside risks to nearshoring, the new government will face the challenge of subdued near-term economic growth (Chart 5). After real GDP contracted by 0.1% quarter over quarter in Q4 2023, Mexico’s economy grew by 0.1% in Q1 and 0.2% in Q2. Even the modest Q2 uptick was chiefly due to a 2.5% quarter-over-quarter decline in imports, symptomatic of weak domestic demand amid a 0.6% fall in private consumption.

Domestic weakness and expectations for a slowdown in the US have led to respondents’ projections for growth in Banxico’s surveys deteriorating (Chart 6). The private sector is currently forecasting expansions of 1.3% in 2025 and 2% in 2026, down from 2% and 2.4% in January.

We believe the average 2024 forecast of 1.5% to be overly optimistic. Current conditions likely will see growth much closer to the Bloomberg consensus of 1.1%. Uncertainty regarding domestic activity and foreign investment will make forming the government’s 2025 budget – due in November – a tricky process (Chart 7).

This follows AMLO’s administration's pivoting away from relative fiscal prudence over the pandemic ahead of the elections. Indeed, increased social and infrastructure expenditures alongside higher interest costs have widened the overall deficit, which has averaged 4.3% of GDP over the past year.

It will be politically tricky to significantly lower spending at the risk of exacerbating economic headwinds while muted activity hampers revenues. Expenditures related to the long-struggling state oil company Pemex remain a fiscal constraint. As such, the deficit is expected to narrow only modestly in 2025. That said, Mexico’s debt load (41.9% of GDP in 2023) will likely remain small compared to other emerging markets (e.g., Brazil: 74.4%) and developed economies (US: 130.2%).

Banxico will lower rates further, albeit cautiously

Banxico must strike a delicate balance to support the economy while containing domestic and external price pressures. In September, it lowered its policy rate by 25 bps to 10.5%, the third move this year. Despite heightened peso volatility, the central bank cited confidence regarding ongoing disinflation and downside risks to growth as reasons to ease monetary policy (Chart 8).

This came after the second consecutive September decline in mid-month inflation to 4.7% year over year and the start of the Fed’s own easing cycle.

We expect that weak growth, high-frequency measures of core inflation now running at levels broadly consistent with Banxico’s 3% target, and a declining fed funds rate will together lead the board to lower the policy rate by a further 50bps over its next two meetings to 10% by year-end.

Final thoughts

The 2025 rate trajectory will be impacted by the outcome of the US election (Chart 9). The result is currently a coin toss.

In our view, a baseline of a Harris victory would see lower pressure on the peso and provide Banxico room to cut to a rate of around 8% by the end of 2025. This would mark only slightly more cutting than our forecasts for the Fed. Still, Banxico would have scope for further easing should markets see inflation and domestic political developments more favorably.

Should Trump win, Banxico would most likely take a more cautious path. This outcome would exacerbate currency volatility risks, alongside scrutiny of the government’s fiscal policy, reforms, and relationship with the US. This would likely see cuts curtailed to 8.75–9.00% by the end of 2025.

Important information

Projections are offered as opinion and are not reflective of potential performance. Projections are not guaranteed and actual events or results may differ materially.

Foreign securities are more volatile, harder to price and less liquid than U.S. securities. They are subject to different accounting and regulatory standards, and political and economic risks. These risks are enhanced in emerging markets countries.

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