Since the global outbreak of coronavirus in March, the Bank of Mexico has carried out two consecutive interest rates cuts of 50 basis points each in between meetings. These cuts align with the trend seen in global central banking due to the impending recession risks. The cuts also follow suit with the gradual easing path that Banxico embarked upon last September.
In the last inter-meeting announcement, Banxico also implemented a series of unprecedented moves to purchase securities and support financial market liquidity, amounting to MXN750 billion or 3.3% of 2019 GDP. Measures included facilities for repurchase agreements on government and corporate debt and funding for loan schemes to small businesses via commercial and government banks. Banxico also allowed currency hedge sales of non-resident counterparties off-hours, in a bid to reduce peso volatility in Asian and European trading sessions. USD funding had previously been supported by fine-tuned credit auctions, financed by a swap line arranged with the Federal Reserve. Markets have been provided with a sixth of the $60 billion liquidity Fed fund, while domestic dollar reserves in Banxico´s vaults register a nearly 5-year record high, at 186 billion.
Mexico’s target rate is currently sitting at 6%, the lowest in 3 years…
Yet, the official overnight rate remains considerably higher than both the estimated neutral range and the Fed’s benchmark. Banxico has consistently echoed its conservative approach towards gradual monetary easing due to concerns over currency and capital account pressures. With over a quarter of the peso value against the dollar already lost and a record outflow pace from Mexican government securities, Banxico is urged to conserve its prudent policy stance. Moreover, the main reasoning behind the relatively hawkish approach is: i) the remarkably high uncertainty in the inflation outlook and ii) the lower effectiveness of monetary policy in isolation amid a notably shy fiscal policy response.
These criteria leads us to believe that, even though Banxico will likely slash its policy rate by another 50 basis points in the May 14th meeting and some 100bp more thereafter, Banxico´s moves will be mainly aimed at reinforcing market stability and reducing financial distortions.
A major quantitative easing policy, similar to the ones seen in developed markets, is unlikely given the rigid nature of the fiscal response. As these policy moves are priced in by markets already, currency volatility upon the announcement should be relatively short, although the bar for surprises is still low when it comes to the Mexican economy.
The Mexican macroeconomic outlook is particularly grim amid the present global downturn.
Seasonally adjusted GDP fell 1.6% QoQ (2,4% YoY) in the first quarter of the year, following four quarters of negative growth of 0.1% over the last year. The government foresees a contraction of up to 3.9% this year, but the most bearish market forecast is for a 12% plunge, almost twice the 6.5% drop in 2009 during the global financial crisis. Mexico’s President Andrés Manuel López Obrador hinted at possible reopening plans from lockdown measures as early as May 17th, after health officials predicted the nation could reach the peak of contagion curve this week. However, with Covid-19 cases rising by more than 1,000 per day, it is not clear whether the predictions will prove true. In this context, further decisions to conduct unscheduled rate cuts cannot be disregarded, as Banxico’s policy moves reflect the increasing uncertainty surrounding the Mexican economy.
Banxico will likely keep easing interest rates, although at a more cautious pace than in the previous recession.
Author: Olivia Alvarez Mendez, FX Market Analyst