The Mexican peso (MXN) appreciated in February, driven by a hawkish stance from the central bank of Mexico, Banxico. However, according to economists at MUFG Bank, further gains are likely to be limited as Banxico is expected to promote more moderate 25 bps hikes in upcoming meetings. Higher interest rates, while keeping the currency attractive as a carry currency, will also create headwinds. MUFG Bank predicts that later in the year, Banxico will start cutting its policy rate when inflation slows down.
Currently, the exchange rate between the US dollar (USD) and the MXN stands at around 20.03, but MUFG Bank predicts that this will drop to 18.4 by Q1 2023, with slight increases in Q2, Q3, and Q4 of that year.
In terms of risk factors, MUFG Bank cites two potential contributors to MXN weakening. Firstly, the US economic slowdown and potential recession may hit the inflows into Mexico from trade, direct investments, and wage remittances. Secondly, President Lopez Obrador’s nationalistic policies, particularly those concerning the energy sector, may discourage private investment. However, MXN may continue to be supported by investment and exports from companies reallocating global supply chains into Mexico.
The Future for Banxico
It is important to understand the role Banxico plays in shaping the economic landscape of Mexico. Banxico is tasked with setting interest rates to achieve monetary and financial stability. Over the past few years, Banxico has pursued a hawkish monetary policy focused on keeping inflation under control. The policy has required consistent increases in interest rates to support the economy and tackle inflation.
Looking forward, Banxico is expected to continue its rate hike strategy but with more moderate moves. This is because the bank believes that the inflation target is being achieved, and further rate hikes will not be feasible in a scenario where fiscal policies are increasingly expansionary.
In terms of inflation, the National Consumer Price Index (NCPI) grew by 0.53% MoM in February 2021 compared to 0.48% MoM in January. The non-core component of the inflationary basket, which includes energy and agricultural product prices, registered a monthly change of 2.81%. Meanwhile, the core component of the inflationary basket, excluding volatile items, registered an inflation rate of 0.18% MoM.
The Mexican economy witnessed a decline of 8.5% YoY in 2020, with the economy contracting in all four quarters of the year. Mexico’s GDP is expected to see moderate growth, with a rate of almost 4% in 2021, followed by an estimated growth rate of around 2.1% in 2022, as per IMF projections.
The scenario paints a cautiously optimistic picture of the economy, which has weathered storms in the past through prudent macroeconomic management. Historically, the Mexican peso has been volatile, closely tied to fluctuations in oil prices, given the country’s oil exports. However, the country has made efforts to diversify its economy, reducing its reliance on oil in recent years.
Risk Factors
The first risk to the Mexican economy identified by MUFG Bank is the potential slowdown or recession in the US economy. As the US is Mexico’s largest trade partner, any decline in the US economy will have a ripple effect throughout the Mexican economy. A slowdown in the US could dampen consumer spending, reduce the demand for Mexican goods and services, and ultimately harm Mexico’s economy.
Secondly, President Lopez Obrador’s nationalistic policies may discourage private investment in the Mexican economy. The energy sector is particularly vulnerable to both the COVID-19 pandemic and the President’s policy changes. The cancellation of contracts and curtailing of investment incentives may deter foreign as well as domestic investment. Moreover, the recent restrictions on foreign imports of fuel may lead to price increases, hampering economic growth.
Positive Factors
Despite these risks, the MXN may continue to see support from investment and exports through global reallocation of supply chains. Companies are looking to diversify their supply chains given the pandemic-related disruptions and rising tension between China and the US. Mexico is proving to be a viable alternative as it offers an efficient, reliable, and relatively low-cost market. As such, the country is receiving growing investment interest, particularly from the tech industry, which bodes well for the MXN.
Conclusion
The MXN’s appreciation in February was due to a hawkish Banxico policy. However, further gains may be limited, given the expected moderate rate hike strategy that is expected to be implemented. Two factors pose a risk to the Mexican economy- the potential slowdown/recession in the US and President Lopez Obrador’s policies on the energy sector, which may discourage private investment. Despite these risks, the country may see increased investment and growth owing to its reliability, a diverse economy, and low-cost opportunities for investors.
