Banxico Preview: A tough call to make - Rabobank

Christian Lawrence, Senior Market Strategist at Rabobank, suggests that their base case for Banxico has been that they will follow the Fed but outside of that, the hiking cycle will be very much reliant on the performance of USD/MXN.

Key Quotes

“To that end, we suggested that a rapid move to 20 in USD/MXN could push Banxico to act, particularly if CPI inflation edges higher, which it has been, albeit only moderately so. This is not to say that raising rates will be an easy decision, if we exclude the currency then we would suggest little need to raise rates at the moment but of course we cannot do that. Instead, we have a central bank facing the risk of rising price pressures through excessive currency depreciation that is being driven by exogenous factors.

According to our analysis, MXN is the highest beta currency globally. More importantly, there is the role of USD/MXN as the ‘Trump Trade’ of choice for speculators.

The only real course of action the Bank has to combat MXN weakness is to try and increase the carry attractiveness (interest rate differential / volatility) to discourage shorting by boosting the numerator (raising rates). Previously the Bank tried to decrease the denominator (lower volatility) with its automatic stabilization program that was triggered by sizeable moves in USD/MXN but this merely led to reserves falling with little success in dampening volatility.

In our view, FX intervention would prove futile and expensive given that MXN is the 10th most liquid currency globally with average daily volume of USD 112bn (43bn spot, 12bn outright forwards, 36bn FX swaps, 15bn currency swaps and 6bn options) according to the latest BIS Central Bank Triennial Survey released earlier this month. Mexican FX reserves are sizeable at USD 175.87bn but as we know, when called to action, FX reserves can evaporate quickly. Mexico could of course implement some form of capital controls but decades spent liberalizing markets is unlikely to be unwound and we view this as highly unlikely.

So what of this week’s meeting? We are the first to admit that this is a difficult call to make. Despite the rise in USD/MXN towards the 20 handle we think Banxico shouldn’t raise rates and instead should keep its powder dry as we head towards the US Presidential election.

The odds that the Bank may opt to keep rates unchanged have increased after the market declared that Hillary Clinton won the first of three presidential debates with Donald Trump as reflected in the sharp retracement in USD/MXN. That said, other than the CNN poll which skewed the victory heavily towards Clinton, most other snap polls showed Trump as the victor. Uncertainty remains.

Even if Banxico does raise rates, if Trump surges ahead and wins the election then USD/MXN will rally dramatically regardless of Mexico’s interest rate decision this week. As such, we view it as best to wait until the November election. That said, our job is not to prescribe policy but to predict it and given that a 50bp hike is almost fully priced in, a lack of action could see 20 breached regardless of Trump’s polling which the central bank does not want to see. That said, as we mentioned before, 50bp is unlikely to prevent MXN depreciation and so on balance we suggest the Bank will wait. That said, this is a very difficult call and there is significant risk of a rate hike from the Bank. Unfortunately, we cannot say that our “no change” forecast is a high conviction call but on balance we think it is the likely outcome.”