Itaú BBA - Recovery at Last

Scenario Review - Mexico

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Recovery at Last

julio 8, 2014

Mexico’s IGAE (monthly proxy for GDP) recovered in April.

• Mexico’s economy likely picked up in 2Q14 as the recent indicators for manufacturing activity improved substantially. We expect 2.4% growth for 2014 and 3.8% for 2015.

• Inflation rose in the first half of June, to 3.7% (from 3.58%), and will likely continue climbing within the next few months, mainly due to volatile agricultural prices and a low comparison base. However, we expect it to decrease towards the end of the year. We see inflation at 3.7% by the end of 2014 and at 3.2% by the end of 2015.

• As the economy recovers, we do not expect further rate cuts. We see the policy rate at 3.0% by the end of this year. In 4Q15, the start of a hiking cycle is likely, and we see the policy rate at 3.5% by the end of the year.

• In spite of the recent policy rate cut and our expectation of higher (than priced in) U.S. treasury yields, large capital flows associated with the reform agenda will likely limit the depreciation of the exchange rate. We see the peso at 13.2 both by the end of this year and by the end of 2015.

The secondary laws of the telecommunication reform were approved on July 4. The congressional voting on the secondary laws of the energy reform has been postponed, but it will probably take place in the first week of August.

A Rebound Begins 

Mexico’s IGAE (monthly proxy for GDP) recovered in April. The index came in at 0.5% year over year in April, after an upwardly revised 3.24% expansion the previous month. However, calendar effects were unfavorable in April so the working-day adjusted series gained a solid 2.9% year over year in April as both services (3.1%) and the industry (2.6%) grew strongly. On a sequential basis, the IGAE expanded 1.2% from March and by 2.4% qoq/saar.

Manufacturing activity is driving growth, lifted by a solid expansion in U.S. industry. In April, manufacturing output was up by 8.9% qoq/saar. Manufacturing exports increased by 1.3% from April to May, boosting quarter-over-quarter growth to 23.3% (annualized), as auto exports were up by an impressive 44% qoq/saar.

There are also signs that internal demand is improving. Retail sales were up by 1.1% from March to April, after a 1.2% increase the previous month. Imports of consumer goods ex-fuel grew 37.9% qoq/saar in May. The improvement in consumption comes with an acceleration in job creation (formal employment increased by 3.0% year over year in May, up from 2.8% in April) and better (though still low) consumer confidence. Meanwhile, imports of capital goods – which closely track investment in machines and equipment – were up by 3.3% from April to May, but their trend continues to be weak (at 3.3% qoq/saar).

Our growth forecasts stand at 2.4% in 2014 and 3.8% in 2015. We note that our growth forecast for this year implies above-potential growth rates from 2Q14 on. Mexico’s economy was hurt by the strong contraction in U.S. economic growth in 1Q14, alongside tax hike effects on consumption. However, the recovery of the U.S. industry coupled with loose domestic monetary and fiscal policies are now supporting a recovery. In 2015, growth will also be supported by the first impacts of the reforms. 

Inflation Enters Into a Temporary Upward Path

Annual inflation has started to rise, mainly due to volatile agricultural prices and a low comparison base. Headline inflation reached 3.7% in the first two weeks of June, up from 3.58% in the second half of May. While core inflation continued around the target center (at 3.08%), non-core inflation grew to 5.78% (up from 5.35%) due to higher non-core food prices, which increased by 2.88% (previously 1.20%). In all, we expect year-over-year inflation to climb higher within the next few months, probably breaching the target ceiling.

For the end of 2014, our inflation forecast remains at 3.7%. In 2015, the impact of tax hikes will fade and we expect inflation at the end of the year, at 3.2%. Inflation fundamentals continue to be well-behaved. The exchange rate has been stable, demand is contained and inflation abroad is low. For the end of 2014, our inflation forecast remains at 3.7%.

A Non-Unanimous Decision

The minutes of the latest monetary policy meeting show that the decision to cut the reference rate by 50 bps to 3.0% in June was not unanimous. Three board members voted in favor of reducing the reference rate by 50 bps, while two voted to maintain the rate unchanged. Board members who voted in favor of a cut gave four main reasons for their decision: i) the lower-than-expected economic performance in 1Q14; ii) inflation, which behaved better than estimated (no second-round effects from the tax hikes introduced at the beginning of the year were observed, and inflation expectations remain anchored within the target range); iii) the orderly management of public finances; and iv) the looser monetary policy stance in the U.S. 

In spite of the divergence of opinion among the board members regarding the interest rate cut, the minutes emphasized the message sent in the press statement announcing the decision: “additional rate cuts are not recommended in the foreseeable future.” We see rates remaining unchanged this year and a hiking cycle at the end of 2015 (as the Fed raises rates). However, we note that the board’s commitment to keeping rates on hold is conditional on the economic recovery. If Mexico’s economy fails to rebound (which is not our baseline scenario) and the monetary policy stance in the U.S. continues to be loose, a further easing of monetary policy in Mexico is possible. 

Reforms to Support the Peso

We see the peso at 13.2 to the dollar both by the end of this year and by the end of 2015. Although we expect U.S. treasury yields to rise faster than the market is pricing in, we do not see room for a large depreciation of the peso. A successful implementation of the approved reforms will probably attract significant capital inflows to Mexico, offsetting the tighter financial conditions in the U.S. Finally, we note that even after the recent policy rate cut, the Mexican peso did not significantly underperform other EM currencies.

Energy Reform Bylaws Approval Delayed

The vote on the secondary laws of the energy reform in congress has been postponed, and it is now expected to take place in the first week of August.The PAN party conditioned its support of the bill on the approval of a proposed political-electoral bylaw in 17 states (which will have elections next year). To date, only one of these states have not adopted the bylaws (Nuevo Leon). The state, however, will likely vote on these laws soon, clearing the way for the debate on the energy bill.

Meanwhile, the secondary laws of the telecommunication reform were approved on July 4 in the senate. The lower house of congress will vote on them and likely approve them very soon.


 

João Pedro Bumachar

Jesus Gustavo Garza-Garcia



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