Banxico to hike 25bps on inflation and Fed - TDS

Sacha Tihanyi, Senior Emerging Markets Strategist at TDS reiterates their call for a rate hike at today’s Banxico meeting. Inflation dynamics, while improving, continue to be too unsatisfactory to end monetary tightening at this point, they further adds.

Key Quotes

“Monthly outcomes on core inflation prints are showing a degree of easing, thanks to the service sector, though core non-food merchandise prints remain an issue (reflecting previous FX pass-through and a degree of second round effects). This has meant little evidence of a near term turn in core year-on-year inflation, save for on the services sector.”

“This will imply a remaining degree of caution for Banxico considering that inflation expectations, though having improved, have failed to show greater downside retracement on the medium to longer-term inflation expectations surveys. Five and ten-year breakevens have come back down below 4%, but remain well above the level before the U.S. election last year. While not overly concerning, these measures of expectations imply that Banxico does not have the luxury of a “free pass” on inflation, given the message that it sends a negative message to markets; ending a hiking cycle at a point where expectations remain elevated AND overall inflation dynamics have yet to peak on a Y/Y basis.”

“The most recent quarterly inflation report struck a decidedly more hawkish tone, and particularly so in the comments given by Governor Carstens in the accompanying press conference. That the Governor expressed a view that the policy rate was only now at neutral, and that it was important to act preemptively to contain CPI, was surprisingly hawkish. This degree of hawkishness, and the characterization of monetary settings, suggests that it’s not unimaginable that we get one more CPI-focused hike, however this may be only a 50% consideration in light of the Fed action. Going forward, we think that a definite peak in core (aided by momentum loss in the merchandise component), and a further drop in expectations will take the CPI pressure off of Banxico.”

“In the wake of the Fed’s 25bp rate increase, the case for a 25bp Banxico rate hike is made even more firm, given that the central bank has not as of yet indicated any de-prioritization of the rate differential as a policy factor (second most important, according to the previous policy statements). However, we can also see the potential that Banxico will begin to signal a lessening tether to the Fed, considering that yield-to-vol is now well above levels associated with persistent MXN weakness and portfolio outflows from the short end of government fixed income market.”

“This implies, outside of a massive increase in market volatility, that Banxico may begin to feel increasingly comfortable in deemphasizing the Fed tether. The one caveat is the introduction of the Fed’s balance sheet reduction plan, and TD’s view that the actual plan will be executed in September. This may give Banxico some degree of caution (near term) in de-tethering from the Fed, considering that it may want to see market reaction to such an announcement, though we are of the view that the fundamental impact on MXN should theoretically be nil, particularly at current levels of yield/vol.”