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What Are The Chances Of A Mexico Rate Cut?

Nov 14 2019, 08:33 PM (+06) |

It appears that Mexico’s inflation is finally getting under control. But, at the same time, the economy is starting to sputter. So far it has only barely escaped a technical recession, with growth far from prior levels.

But, the Central Bank finally has room to take action that the government has been pushing for ever since the new President took office.

Despite two cuts so far, Mexico still has the highest interest rate in the world, when taking into account inflation.

This hasn’t done much to encourage capital flows. The Mexican peso has been under pressure due to increased capital outflows, as well as the rate cuts. And that trend doesn’t seem likely to change soon.

What We Are Expecting

Not only is there a strong consensus in favor of a rate cut, but there is even a majority chance of a 50 basis point cut this time around.

In the last meeting, the vote was split between cutting 25 or 50 bps. Three of the five members voted for the former. Although Banxico did not give forward guidance, the statement was quite dovish.

The thought is that one more member will vote for a 50bp cut later today, bringing the rate to 7.25%. The swaps spread has moved to project that the rate will reach that level by the end of the year, and there is still one more meeting.

But, conventional wisdom is that the bank will take a more aggressive stance to catch up with the easing cycle in other countries, notably the US with which it has had an increasing rate spread after the Fed cut rates.

The Market Reaction 

It should be noted that a poll of economists by Reuters found that just 10 out of 14 favored a rate cut, and the Banxico is notoriously cautious about cutting rates.

A hold would, however, be quite a surprise for the markets, as it is currently pricing in at least a 25bp cut. That would be the scenario in which we’d expect the least market reaction.

The next factor is the wording in the monetary policy statement. Last time it was dovish, but the expectation is for it to be more explicit this time around. We could see some market adjustment if they finally provide guidance. However, there isn’t an expectation that we will get a forward-looking rate path like other central banks do.

The Outlook

Even if there is some discrepancy in the timing of rate cuts, among analysts there is a pretty strong consensus that over the next couple of months the inflation rate will continue to shrink. This is mostly thanks to lower basic goods costs. At the same time, the economy is expected to perform at the bottom of the projected range.

Both would be indications for the central bank to continue an easing cycle, including a total of 50bps by the end of December. The discrepancy is whether the bank will do the whole thing later today, or spread it over this and the next meeting.

However, the MXN has been performing better than most other emerging markets. In fact, it has increased since the Banxico finally started cutting rates. This not only could help allay fears by the central bank of currency weakness but also tell traders that rate cuts don’t necessarily mean increased weakness in the currency.

And with the USMCA expected to be ratified soon, the peso could be in for further strength!

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