In charts: Mexico’s Trump rate dilemma

Posted on September 29, 2016

Trump v Clinton in the US on Monday. Trump v Carstens in Mexico on Thursday. 

Agustín Carstens, Mexico’s central bank governor, and the bank’s board face a tough choice at the last monetary policy meeting before the US election: whether or not the peso’s collapse to historic lows this week on fears of a Donald Trump victory warrants a rise in the interest rate from its level of 4.25 per cent. 

In financial markets, the jury is out, especially after Monday night’s debate. 

Before the face-off, the market consensus had been for a 50-point rise — and some even pencilled in 75 points. The free-floating peso has taken an unprecedented hammering as polls showed Mr Trump — whose protectionist and anti-Mexican rhetoric has sparked alarm south of the Rio Grande — draw level with Hillary Clinton. 

But her superior performance on Monday could give Banxico pause for thought as the peso pulled back some 2.5 per cent of its losses after the debate.

“I think Carstens loves Trump today. A 50 centavo collapse in the USD-Mexican peso rate should mean a 50 basis point collapse in rate hike expectations,” said Eduardo Suárez, who heads Latin America macro research for markets and banking at Scotiabank in Mexico City. 

The market remains split on the prospects for what would be Mexico’s third rate increase this year. Here are some of the main factors influencing Banxico’s decision: 

Prices: the only way is up

Banxico is vigilant on inflation and the latest data showed retail prices rising faster than expected. Inflation in the 12 months to mid-September was 2.88 per cent, above expectations. Inflation has been at historic lows and that is still comfortably within the bank’s 3 per cent target. So why worry? In short, because the only way is up. Though peso weakness has not fuelled widespread price rises yet, core inflation is at its highest level since late 2014. The weak peso is seen as spurring a spike in the price of medicines, and petrol prices are expected to rise sharply next year as Mexico is set to import more US gasoline at a higher cost and to pass that on to consumers if, as the government proposes, domestic fuel prices are liberalised next year. 

But the economy remains sluggish

Banxico has no overheating economy to tame with a rate rise: in fact, the latest official data show the economy expanded just 0.3 per cent in July compared with June, a slowdown after growth of 0.6 per cent expansion in June compared with May. Indeed, Mexico suffered its first contraction in three years in the second quarter and the central bank is expecting growth of 2-3 per cent this year. 

‘Shock and awe’

The central bank tried “shock and awe” in February, coupling a 50-point extraordinary rise, taken outside its usual rate-setting schedule, with market intervention. That was when the peso was at 18.2 to the dollar. This week, it was within a whisker of 20. It has since recovered ground but the elections are still more than a month away. A rise now could see Banxico potentially wasting a bullet if Mr Trump rallies and the peso crashes again. BBVA is betting on an increase: “Even recognising that the effects of tighter monetary policy on the exchange rate might be small, we think that Banxico should hike to mitigate the risk of sudden portfolio outflows,” it said.

Intervention?

Could Banxico and the finance ministry choose market intervention instead? BBVA noted speculation against the peso had soared so if the authorities stepped into the market, that would make the Mexican peso more expensive and thus less attractive. But the central bank will be cautious of blowing through its $176bn of reserves. Brokerage Finamex said the authorities could sell dollars when the peso depreciated on advances by Mr Trump and buy them back when Mrs Clinton rallied. The bottom line, though, is that the peso’s volatility has almost certainly not finished yet. 

‘Living off loans’

Higher rates will only make debt more expensive and the central bank is already worried enough. It has warned about Mexico’s increasing debt load, and José Antonio Meade, the new finance minister, says the country has developed the bad habit of “living off loans”. Net debt to GDP has risen sharply, from 33.6 per cent in 2010 to an anticipated 45 per cent this year, according to S&P Global Ratings, the rating agency, which has put Mexico on notice that it could lose its coveted investment grade rating within two years if it fails to buck up. That is not helped by the prospect of Mexico’s lowest oil production in nearly four decades this year and a sense of political paralysis with President Enrique Peña Nieto’s popularity in the basement.

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