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And the winner in the U.S.-China trade war is...Mexico? It might be if President Andrés Manuel López Obrador could stop shooting himself, or Mexican business, in the foot.

Asian neighbors like Vietnam and Taiwan have been the hottest destinations for manufacturers hedging their bets on China. But half a dozen electronics firms are also shifting production to the U.S.’ low-wage southern neighbor, according to Nomura research. That has helped boost Mexican exports by 6% this year.

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Mexico has caught other tailwinds over the past few months. Oil prices firmed after sharp declines from May to August. U.S. interest rates headed down again, leaving room for Mexico, like other emerging markets, to cut and spur growth. That has fueled a 14% jump in the iShares MSCI Mexico exchange-traded fund (ticker: EWW) from a mid-August low. The peso has climbed 3.5% against the dollar.

But AMLO, as the Mexican leader elected in July 2018 is known, seems determined not to capitalize on this market momentum. Gross domestic product growth has ground to a virtual halt from 2% in 2017. The culprit is a catastrophic 10% drop in investment as domestic business recoils from the president’s perceived caprices. He never repaired confidence after canceling construction of a $13 billion airport that was one-third completed, says Macario Schettino, an economist at the Monterrey Institute of Technology. “The airport decision was understood as confirmation that he doesn’t like private entrepreneurs,” he says.

AMLO, who has promised a “fourth transformation” to shrink poverty and inequality, has tilted pragmatic on occasion, lately calling on investors to join government in a $400 billion infrastructure overhaul. But this is overshadowed by “laws that make no sense,” like allowing the state to seize any property where certain crimes were committed, says Luis Maizel, Mexican-born founder of LM Capital Group. “It’s one step right, two steps left,” he says.

What AMLO’s Mexico has become is a paradise for bond investors. The central bank maintains a stiff 7.75% prime rate even as inflation cools to 3%. The only other big sovereign borrowers with comparable real returns, Turkey and Russia, are cutting faster, says Aaron Hurd, senior currency portfolio manager at State Street Global Advisors. López Obrador has delivered two conservative budgets despite his transformational rhetoric, quieting fears of a fiscal blowup.

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But being a fixed-income magnet entails its own Catch-22. Mexico would have to slash rates by at least a full percentage point to jump-start stalled growth, Hurd figures. But such a cut might spook bondholders and cause a run on the peso, which has clawed its way back to stability after a 40% plunge from 2014-16.

Hurd is betting that Mexico’s central bankers will keep money tight, bond returns rolling, and growth sputtering. “I’m not very worried about the carry trade for the next three to six months,” he says. “But we have gone to maximum underweight on Mexico’s long-term growth.”

Nuno Fernandes, an emerging markets portfolio manager at GW&K Investment Management, sees a brighter horizon for Mexico based on a “young and unleveraged” population and a stock market dominated by well-run consumer-facing companies. He expects average profit growth near 10% this year despite stasis in the larger economy.

And by the way, manufacturing labor is 25% cheaper in Mexico than China these days, averaging $4.80 an hour against $6.50. If AMLO would meet business halfway, that could power a real transformation.

Email: editors@barrons.com