Itaú BBA - Renewed peso volatility

Scenario Review - Mexico

< Back

Renewed peso volatility

June 9, 2016

As the peso recouples with its fundamentals, additional rate hikes this year are unlikely.

Please see the attached file for all graphs.

• The Mexican peso depreciated sharply in May, and it remains one of the worst-performing currencies this year. The weakening occurred in spite of the ongoing recovery in oil prices and all the fiscal and monetary tightening measures that authorities took earlier in the year.

• We maintain our forecast that the Mexican peso will finish both this year and the next at 17.5 pesos to the dollar, which means an appreciation from the current levels. A further recovery of oil prices, the implementation of the announced fiscal consolidation measures and a rebound of manufacturing exports will likely help the exchange-rate, in an environment of low interest rates in the U.S. (we now expect only one hike by the Fed this year).

• As the peso recouples with its fundamentals, additional rate hikes this year are unlikely. We continue to expect the policy rate unchanged at 3.75% by the end of this year, although we acknowledge that a return of volatility can trigger rate hikes.

• Mexico’s economy continues to grow at a moderate pace. Consumption remains the engine of growth, while exports are weak. We expect growth to continue around the same pace (we forecast growth rates of 2.5% this year and 2.7% in 2017), but with more balanced contributions from internal and external demand.

Renewed peso volatility

At the beginning of May, Mexico’s central bank left the policy rate unchanged at 3.75%, as widely expected. As was the case for the previous meeting, the minutes showed that two board members (likely the usually more hawkish ones) were more vocal regarding the need for additional rate hikes. Once again, one of these two members said explicitly that the policy rate differential between Mexico and the U.S. should not narrow, while the two agreed that the central bank of Mexico may need to hike rates independently of the Fed given the uncertainty over the global scenario. The majority of members (three) did not give a clear signal on rates, but the board as a whole continues to pledge that, in preparation for upcoming decisions, it will monitor the following factors (probably in this order of importance): the evolution of the exchange rate, the interest rate differential with the U.S. and the evolution of the output gap.

Nevertheless, the Mexican peso depreciated sharply in May, remaining one of the worst-performing currencies this year to date. The weakening occurred in spite of the ongoing recovery in oil prices and all the fiscal and monetary tightening measures that authorities took earlier in the year.

Governor Carstens recently downplayed the possibility of holding another extraordinary meeting to raise interest rates – and consequently, support the peso – but he didn’t rule out the option. Specifically, he said that the Mexican peso weakness in May was due to external factors and that exchange-rate trading has been orderly, noting that the evolution of the currency last month is different from the trend seen in February (when the central bank raised the policy rate and moved to discretionary intervention). However, Governor Carstens also said that the central bank would act to ensure that the exchange-rate trades on fundamentals, adding that “our hope is to make decisions in scheduled meetings”.

We maintain our forecast that the Mexican peso will finish both this year and the next at 17.5 pesos to the dollar (around 6% stronger than its level at the end of May). Following the more recent weak payroll number, we now expect only one additional rate hike in the U.S. this year (in September). Besides, we expect that a further recovery of oil prices, higher manufacturing exports and the implementation of the announced fiscal consolidation measures will contribute to improve the sentiment with the currency.

Our forecasts for the exchange-rate and for monetary policy in the U.S. are consistent with no rate hikes in Mexico this year. However, we acknowledge that new episodes of exchange-rate depreciation can lead to a reaction by the central bank.

The gap between services and industry is widening

Mexico’s economy grew at a moderate pace in 1Q16, bolstered by resilient growth in services, while industrial activity – particularly oil, manufacturing, and construction – was weak, in spite of an improvement between 4Q15 and 1Q16. The year-over-year growth rate of the IGAE (a monthly proxy for GDP) slowed from 4.1% in February to 1.2% in March, bringing 1Q16 growth to 2.6%. However, we note that calendar effects were unfavorable in the first quarter of the year (even after considering the leap year). After adjusting for working days, the Mexican economy grew by 2.8% in 1Q16, picking up from the 2.4% rate posted in 4Q15, with the service sector leading the expansion (3.6% year over year, vs. 3.7% in 4Q15) and industrial growth improving to 1.9% (from 0.2%), largely due to higher growth in construction (4.0%) after a very weak 4Q15 (-0.5%). At the margin, 1Q16 growth was 3.3% qoq/saar, after a 2.2% gain in 4Q15.

The strong activity in services is consistent with increasing private consumption, which is a result of solid employment growth, low inflation, an expansion of credit and strong growth in remittances (when converted to pesos). The industrial sector, in contrast, is evolving poorly due to weak manufacturing output in the U.S. and declining oil output (because much of the fiscal expenditure cuts go through Pemex).

More recent numbers suggest that consumption remained strong in 2Q16, while manufacturing exports are still weak. The same-store-sales indicator produced by ANTAD (a retailer association) grew by 10.1% in April, following a 5.8% increase in March, and domestic auto sales gained 19.2% year over year in May. On the other hand, manufacturing exports (measured in current dollars) contracted once again in April (by 5.8%, corrected for calendar effects).

We still expect Mexico’s GDP to register the same growth rate in 2016 as it did in 2015 (2.5%). More balanced growth is likely, as we believe that U.S. manufacturing will gain some traction (the ISM is already running above 50), helping to improve exports from the second half of this year onward. On the other hand, some moderation in services is likely as consumption growth slows. In fact, temporary employment (a leading indicator for overall employment) is running low and inflation will probably rise somewhat in the months to come, eroding real wage growth. In addition, as the exchange rate stabilizes, the impulse from remittances will fall.

For 2017, we expect some acceleration, to 2.7%. The economy next year will be helped by the U.S. industry and higher oil prices (which will help the government to meet its fiscal targets without sacrificing expenditures much).


 

João Pedro Bumachar
Alexander Andre Muller


 

Please see the attached file for all graphs. 


 


 



< Back