Another Rate Cut Out of Mexico?

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Mexico no longer has the highest interest rates in the world. But, that doesn’t mean their central bank isn’t still looking to ease further.

Inflation hasn’t picked up significantly since the Banxico embarked on its latest easing cycle. However, neither has the economy.

There were reasons to suggest that Mexico would be a beneficiary of the US-China trade tensions. And the USMCA finally removed that bit of uncertainty. However, that hasn’t shown in the data.

The consensus among polled economists shows a strong inclination towards a fifth consecutive rate cut. That puts the rate at 7.25%.

This would imply that the interest rate spread with the US closed by 50 basis points, cutting the interest premium for Mexican assets to a similar level to mid-2017. In that period, the USDMXN drifted from the 17.70 handle to a little over 18.70.

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New Rules?

In the lead-up to the decision, the Banxico has issued new guidelines to members and analysts about improving their communication. Most are of a technical nature, but regulators are making an effort to curb speculation about the rate ahead of the official announcement.

New rules include a seven day blackout period ahead of the rate announcement. They also include a promise to use less complicated language in press releases.

Neither should affect the underlying fundamentals of the decisions that the Banxico makes, of course. However, the market might react differently to a new format.

An important part of the market reaction to a central bank statement is the language used. So, there could be some extra volatility this time around as traders adjust to the new format and compare it with prior announcements.

Going Forward

The other matter is what to expect from the central bank going forward. The Banxico does not issue a dot matrix like the Fed does. But, we can have a look at the trajectory plotted by expectations from economists.

There is currently an expectation of three interest rate cuts this year, after the one projected for tomorrow.

This would mean that the interest rate would close out the year at 6.5%. For 2021, an additional two rate cuts are expected and appear to be priced in by the bond market.

The Situation

All of that supposes that inflation stays below 4.0% and the economy doesn’t take off.

Last month’s inflation was ahead of expectations, while industrial production continued to shrink.

Some analysts point to Mexico potentially having benefitted from the economic turmoil caused by the coronavirus in the Far East. This is because US importers are looking for other sources of supply with many Chinese firms shut. And we would normally expect this to provide some strength to the peso.

The USDMXN has remained largely stable during the easing cycle, helped, in part, by a drop in credit default swaps during the same period.

Mexico remains one of the few high-yield carry plays in a world racing to lower rates. With little expectation of rates to rise in other countries, the peso could stay strong. This is true even if the Banxico continues along the expected easing track.

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