Breakevens Show Banxico May Need Another Inflation Reality Check
(Bloomberg) -- Mexico’s central bank accepted economic reality and raised its inflation forecasts in Thursday’s rate decision. The pricing of inflation-linked bonds indicate it didn’t go far enough.
Policy makers increased their year-end estimate to 5.7% from 4.8% and pushed the date of convergence to the 3% target into 2023 from 2022. Even so, traders and economists doubt the dovish-leaning central bank can deliver on those expectations.
The so-called breakeven rate on two-year debt narrowed on the day, but did little to reverse the 25 basis-point jump this month, pricing in inflation of 4.3% in two years, while Banco de Mexico predicts 3.1%. That skepticism has much to do with the central bank itself, which has taken a more dovish turn under President Andres Manuel Lopez Obrador. While policy makers hiked rates for the second meeting in a row Thursday, they were once again split, with two of five officials dissenting in favor of no change.
“The upward revision was to be expected, but it still seems to fall short,” said Claudia Ceja, a strategist at BBVA in Mexico City.
The central bank’s 5.7% inflation forecast for the end of this year trails economist consensus of 6%, according to the latest Citibanamex survey. Ceja sees it at 6.2%. Policy makers have repeatedly said that the pick-up in inflation will be transitory.
The two members who objected to the rate hikes this week and in June were both appointed by Lopez Obrador, potentially indicating the direction the president wants to see for monetary policy.
Still, swap markets are pricing approximately 75 basis points in extra tightening by the end of the year, or 25 basis points at each of the three remaining meetings. The market also prices an additional 80 basis points of hikes next year, even though Lopez Obrador’s fourth appointee to the five-member board -- former Finance Minister Arturo Herrera -- will likely take over as governor in January.
Benito Berber, the head of Latin America economics at Natixis in New York, says Thursday’s split decision shows the resistance to whacking up rates and the outlook for inflation.
“This, obviously is a dovish signal, because it suggests that as soon as Herrera assumes as governor, the probability for a pause will increase,” said Berber.
Berber expects two more 25 basis-point hikes from the bank by the end of the year, and a pause when Herrera steps into his new role. Economists surveyed by Citibanamex agree, predicting a total of 50 basis points by the end of the year.
Yet even if Banxico disappoints the swap markets, it may not undermine the peso. BBVA’s Ceja says the currency will likely still be supported by the nation’s strong carry, and that fewer hikes than priced could support peso-denominated debt, which has seen an exodus of foreigners this year.
“It gives space for a relief rally in the curve,” Ceja said.
The Mexican peso’s one-month implied volatility slumped this week to the lowest since February 2020. Currency stability helps attract carry-seeking flows and benefits the fixed-income market as well.
Elsewhere in the market, Mexican corporate debt edged higher over the week, while both peso-denominated and dollar-denominated sovereign bonds fell.
Next week will be light on economic data. Mexico will report international reserves up to Aug. 13, while Citibanamex will release its survey of economists.
WHAT TO WATCH:
- Aug. 17: International reserves
- Aug 20: Citibanamex survey of economists
- Mercader Financial to sell 450m pesos of local bonds on Sept. 8
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