With events in Argentina have placing investors focus back on LATAM, the Central Bank of Mexico (Banxico) has come under increased scrutiny. According to the conventional wisdom, the Mexico peso fell to its lowest value against the USD in 2018 reflecting investors’ concerns over ongoing NAFTA negotiations.
Since mid-April the MXN has depreciated over 8.0%, but broader EM declines suggests dollar rather than Mexican specific factors. Rising US yields and growing geopolitical tensions creating a perfect storm for rationalising EM FX sell-off. With firm US yields and a decelerating of USD and oil price momentum, EM local markets have stabilised last week. The fundamental rationale for USD strength remains weak in our view and see the opportunity for a significant snap-back.
Banxico will likely leave the policy rate unchanged at 7.50%. Yet, there is a high probability of a 25bp hike. Currently the primary concern for Banxico is the level of MXN. Meeting minutes communicate that further MXN deprecation (USDMXN 20.50 estimate) would trigger an increase in policy rates. We believe that further deprecation of MXN against the USD would be required for Banxico to increase policy rate. Elsewhere, tangible inflation has been below Banxico’s forecast for Q1 was 5.5% and inflation but printed at 5.3%. Barring a shock, decline trend of realised inflation suggest easing cycle late 2018.
Our base scenario is that NAFTA will hold up with only slight adjustments. Being called NAFTA 2.0 U.S., Canada and Mexico are concentrating on redrafting the autotrading guidelines. Negotiators now faced with hard deadlines in an election year, raises the possibility of less severe adjustments. The low probability of NAFTA break up should be MXN positive.
Finally, regards to 1st July election, run-up will certainly drive short-term volatility. Our view is that the left-wing, economic pragmatic, presidential candidate, Andres Manuel Lopez, will likely win. Our current forecast is for a lower USDMXN. However, we acknowledge that the MXN continues to be driven by global factors.
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