Mexico Calibrates Rate Cuts To Mitigate MXN Fragility

Mexican inflation

Forex exchange analysts at Barclays favoured to be neutral on the MXN given the prevailing uncertainty in the Mexican forex exchange. Realised volatilities in the currency along with implied volatilites of the USD/MXN have increased significantly. They noted that the 3m implied and realised volatilities averaged 9.5% and 8.3% from 01 up to 22 May, respectively while such period garnered 13.4% and 12.6%, respectively. They likewise have come to conclude that the prospects of the passing of an FDI-led energy reform has weakened while previously unanticipated weaknesses on Mexcian economy erased most forex exchange strategists’ belief of a quick appreciation of the Mexican spot.

Meanwhile, Goldman Sachs revised its 3, 6, and 12-month USD/MXN forecast to 12.90, 12.80 and 12.60, respectively. Originally, their forecast was 12.80, 12.50 and 12.20, respectively. EUR/MXN is forecasted at 17.8, 17.9 and 17.6, respectively in 3, 6 and 12 months respectively. The broker’s current valuation of the USD/MXN is 13.3 while EUR/MXN is 15.9.

Goldman Sachs forex exchange analysts believe that the MXN weakened considerably after hitting 11.98 to the USD in early May. It was driven primarily by external reasons which is the re-pricing of core rates and risk appetite towards Emerging Markets assets spurred by the reevaluation of the near term monetary conditions in the US. Hence, the forex exchange analysts expect that a portion of the weakness to “mean-revert” in the near term, with the assumption that global financial conditions improve while some near term jitters fade away. The MXN will continue to look for support in strong macro fundamentals, a stringent mix of monetary policies and an optimistic outlook for structural economic reforms.

Banxico Strategy

Barclays further noted that Banxico’s alertness to help stir domestic demand can definitely enhance the prospects of the MXN over the medium term. The easing monetary conditions Banxico is strategising will help hasten the economic recovery in Mexico. It thus spur investment opportunities that will gain traction of foreign capital inflows, upon US economy picks up. They anticipate a more frail MXN until forex investors become well informed on Mexico’s energy reform issues on attracting foreign investments that will immediately reverse any news on the MXN.

The global economic events should drive the MXN dynamics. Over medium to long term, more volatility of the USD/MXN has kept forex exchange analysts to remain neutral on the Mexican peso as they feel vagueness about the value of the currency which was further worsened by the uncertainties surrounding the short term indicators of the MXN spot. Given this backdrop, MXN fluctuations are anticipated to continue driven by US political events. Thus the ever changing decisions of Banxico is not viewed to have good trade opportunities from a risk-adjusted investor perspective.

Inflation

Annual core inflation was 2.5%. Mexico’s core inflation reflects the fragile economy as it reached 1.5% 3m/3m which is the range not seen since January 2013 driven by a cut in mobile rates. The core inflation was 0.32% M/M which printed 0.03% M/M in the second half of the month of September. Factored into this data, services prices registered a 0.05% deflation spurred by a strong reduction in professional services prices to minus 11.3% M/M.

Non core inflation has met economists’ consensus expectations. Non core inflation was 0.58% M/M in line with consensus estimate of 0.58%. Egg and meat prices are maintained. There was absence of price pressures while energy prices were flat.

Monetary Policy

Barclays forex exchange analysts now expect an additional rate cut awaits on 6 December. They noted the high frequency indicators last month meant that the economy is still fragile while downside risks to growth persist. September PMI was better but still lower than 50, car production dropped 5.2%M/M spurred by great reduction in domestic car sales by 8.2% M/M. The hurricanes that occurred are expected to create negative impact on primary activities and services. Moreover, US government shutdown poses risks to economic activity in that country and the Mexican economy is the most exposed.

With all the factors mentioned, Barclays is expecting a 25 bps rate cut on 25 October Banxico monetary policy meeting, followed by an extremely dovish statement that would translate another rate cut on 6 December meeting. Overall, the broker is now estimating a cut of 50 bps in the reference rate to post at 3.25% towards the end of 2013 from the prior 3.75%. They are confident with their below-consensus year-end inflation forecast of 3.4% versus consensus estimate of 3.7%.

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