The Mexican peso is exposed to downside pressures given the highly uncertain scenario, both internally and abroad, for which above-neutral interest rates are prescribed.
A restrictive stance of the monetary policy allows the peso to offer a relatively high carry, keeping investors interested in Mexican assets. However, the considerable deterioration of the economy, which almost stalled in the second quarter after having contracted previously, calls for monetary accommodation.
With broad uncertainty weighing on gross fixed capital formation, public spending and consumer confidence, annualised inflation has slowed at a faster pace than expected, by roughly 3.8% each month on average this year.
Rolling this rate ahead, the Mexican economy would hit Banxico’s 3% inflation target by as soon as the beginning of 2020.
As both Pemex´s rating and Mexico’s sovereign rating were recently downgraded to one notch above junk grade by the Fitch agency, while Moody´s revised down their outlook from ´stable´ to ´negative´, Mexican public finances are under pressure to act as a countercyclical policy tool.
External risks in the form of US tariff threats add to the still unratified USCAM trade deal, while global uncertainty from US-China´s escalating tensions is also having its toll on EM currencies in general.
Copyright: Bloomberg Finance LP.
This scenario puts extra burden to the monetary policy to help balancing out the risks faced by the economy. Market implied expectations for monetary easing by Banxico are among the most aggressive in the major economies, with 141 basis points rate cut priced in over the 12-month horizon.
Despite the relatively hawkish tone in the last Banxico meeting, with only one out the five board members leaned towards easing, next week´s announcement should bring stronger signals of upcoming rate cuts.
While we think the beginning of an easing cycle will be delayed to September most likely, downside pressures on the peso will be met shortly, as markets only price in this move as a binary option so far.
Lower yields plus heightened global uncertainty in the short term are poised to erode MXN´s attractive as a popular carry trade currency.