Itaú BBA - Emerging Signs of Recovery

Scenario Review - Mexico

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Emerging Signs of Recovery

Abril 8, 2014

The IGAE (monthly GDP proxy) came in at 0.8% year over year

•           The economy started the year weak, but recent indicators suggest a recovery is under way. Our growth forecasts stand at 3.0% for 2014 and 3.8% for 2015.

•           Inflation declined in February, and core inflation is back to the target center, even after the tax increases. We still see inflation at 3.7% by the end of this year and at 3.2% by the end of 2015.

•           Although we expect the exchange-rate to depreciate slightly from the current levels (once U.S. treasury yields rise), the Mexican peso is likely to outperform the region’s floating currencies. We see the peso at 13.2 to the dollar by both the end of this year and the next.

•           The central bank kept the policy rate unchanged at the March meeting, but the tone of the accompanying press statement and the minutes softened. We don’t expect rate moves this year and we see a tightening cycle beginning during the first half of 2015.

Signs of Growth Improvement 

C. The IGAE (monthly GDP proxy) came in at 0.8% year over year, below market expectations and down from 1.1% in December. The Primary sector fell 1.7% year over year (+1.2% in December), while Services rose 1.0% (+1.9% in December) and the Industrial sector grew 0.7%. On a sequential basis, the IGAE gained a modest 0.1% from December, after a 0.3% contraction the previous month. As a result, activity accelerated to 1% qoq/saar, from 0.75% in December; the Service sector also increased 1% qoq/saar, while the industry gained 0.7%. 

More recent indicators related to exports, however, hint that the activity dynamics are improving. Manufacturing exports increased 5.1% month over month in February, led by a 12.2% gain in the auto component. Non-auto manufacturing exports rose 1.9%. Although the manufacturing export trend remains weak (-6.5% qoq/saar), it is starting to improve; manufacturing exports declined 8.6% qoq/saar in January. In March, the IMEF’s (business association) seasonally-adjusted manufacturing PMI rose to 52.7 (from 50.4 the previous month). The PMI breakdown was even more positive: the new orders component reached 56.1 (from 50.2 previously), the employment sub-index climbed to 53.6 (from 49.2) and the current production component came in at 54.9 (51.8 previously).

There is some positive news for internal demand as well. On the investment side, capital goods imports increased 2.6% between January and February, reaching a quarterly growth rate of 17.2% qoq/saar. Public capital expenditures increased 48.2% year over year in February, taking the three-month moving average growth up to 86.5% year over year. While it is true that base effects favored the sharp increase in public capital expenditures, we estimate that the notable strong growth was also sequential. Meanwhile, the labor market seems to be improving. Temporary employment – arguably a leading indicator for overall employment – increased 3.3% year over year in February, from 3.2% in January and 2.2% in 4Q13, while the drop in inflation since January is also supporting real income. Finally, although consumer confidence levels remain depressed, there was a 4.8% increase from February to March, following the 3.2% increase the previous month. Confidence is beginning to recover from the slump in January, when the tax hikes were introduced.

Our growth forecasts stand at 3.0% for 2014 and 3.8% for 2015. Although the weak IGAE readings for December and January suggest a weak growth rate for the first quarter of the year, the growth dynamics within 1Q14 are improving. We expect above-trend growth rates from 2Q14 on, as the U.S. recovery benefits Mexico’s exports, which will in turn spill over to internal demand. Loose fiscal and monetary policies are also likely to help boost Mexico’s recovery. Next year, the initial impacts of the structural reforms will likely lift GDP growth.

Inflation Returns to the Target Range

Headline inflation fell to 3.89% during the first half of March, down from 4.26% in the second half of February and 4.63% in the first two weeks of the year (when the tax hikes were introduced). Core inflation fell to 2.84% (from 2.99% in the second half of February), as the service component reached 2.85% (from 3.07%), while core goods inflation fell to 2.83% (from 2.9%). Inflation of non-core food items continued on a downward trend, following the rapid increase in 4Q13. Non-core inflation therefore fell to 7.29% (from 8.34%), taking Mexico’s inflation to within the target range. Meanwhile, core inflation is once again below the center of the target despite the impact of tax increases on consumer prices. The numbers suggest that the inflation outlook is not at risk.

We expect Mexico’s inflation to reach 3.7% this year and 3.2% next year. Excluding the tax impact, core inflation has been running between the lower bound and the center of the target for more than a year, which suggests that even with a closed output gap, headline inflation will likely reach the center of the target as the regulated price adjustments are completed and the impact of the tax hikes fades.     

Trade Balance Improves in February          

The seasonally-adjusted trade balance posted a USD 0.4 billion surplus in February – a sharp recovery from the USD 2.1 billion deficit registered the previous month. The improvement was mostly driven by the non-energy deficit, which fell to USD 0.2 billion, from USD 2.3 billion in January. This swing is, in our view, attributable to data volatility, and lower-frequency trade balance measures show that it remains at a level consistent with a low current-account deficit: the trade deficit’s three-month moving average stood at USD 0.8 billion (annualized) in February.       

We expect the Mexican peso to end this year and the next at 13.2 to the dollar. Although we expect a slight depreciation of the peso against the dollar from the current levels in our scenario, we also expect the peso to outperform the other LatAm floating currencies. The benefits of the U.S. recovery for Mexico’s exports and the outlook of foreign capital inflows related to the domestic reforms are likely to drive this outperformance.

Monetary Policy: Better Balance of Risks for Inflation

As was widely expected, the Mexican Central Bank kept its policy rate unchanged at the monetary policy meeting in March, but the tone of both the press statement and the minutes softened. In January, when the previous policy decision was made, the board stated that the balance of risks for inflation had worsened due to global market volatility and the potential second-round effects of the high headline inflation. At that time, the board also saw a better balance of risks for the country’s activity. After that, Mexico’s activity numbers disappointed and inflation has fallen substantially. As a result, in March’s decision the board stated that the balance of risks for inflation has improved “at the margin.” Moreover, the concluding remarks of the statement cite the evolution of the output gap as one of the factors to be monitored in upcoming meetings. The minutes later revealed that most board members believe that the 3%-4% GDP forecast published in the latest monetary policy report will fall in the next report. Nevertheless, the board maintained that it will also monitor the monetary policy stance relative to the U.S. So, in our view, a neutral bias remains.

We don’t expect policy rate moves this year and see a hiking cycle starting only in the first half of 2015, as the FED also begins to raise its policy rate. In our view, the central bank’s recent communication suggests that the board is more inclined to postpone rate hikes than to cut rates. We note that most of the signs of improved activity mentioned above were published after the last monetary policy decision. In a recent interview, Governor Carstens classified the recent economic data as “encouraging”; however, we believe that a debate over rate cuts may emerge if activity fails to pick up soon.


João Pedro Bumachar

 Forecasts: Mexico

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