What Can We Expect From Interest Rates And the Exchange Rate?

By Ernesto O´Farrill Santoscoy; Director of Strategy, Actinver Brokerage House

The statement issued following the Bank of Mexico’s last board meeting in January made it clear that the members of the board begin to see the possibility of a reduction in the bank’s reference rate.

On an external level, it recognized there are still significant risks of a downward trend in the global economy, although these are diminishing. So, faced with lower economic growth, a downward trend in international prices of raw materials and lower estimated levels of inflation compared to last year, expect that in most developed economies and in some emerging, the monetary policy will continue to be very accommodating and that in some countries, there will even be additional easing.

The central bank reports that on a national level, Mexico’s growth rate has begun to slow down. With the deceleration of the global economy, there has been a decrease in external demand as well as aspects of internal expenditure. It also indicated that inflation continued to fall significantly to close 2012 in under 4%, just as expected, at the same time as international prices of the main raw materials have stabilized or started to drop, and the exchange rate is starting to appreciate.

Employment has continued its recovery in line with the growth of the economy, without showing signs of inflationary pressure. The Bank of Mexico predicts that in 2013, general annual inflation will be below levels of 2012 and close to the permanent target of 3%. Due to the current economic stability in our country we expect to see a flow of funds to our economy never seen before; for this year we estimate that up to USD$40 billion could enter in foreign investment, plus another USD$40 billion in foreign financial investment, plus USD$24 billion in remittances.

These three concepts are approximately USD$100 billion, which for our market is a lot. We could start to see these funds if there are signs the reforms could happen and if some of the external issues are resolved (US debt ceiling, and Europe: Spain and Greece).

This could cause the peso to appreciate to USD$12 pesos or more (to USD$0.08333 dollars to the peso). In other words, the exchange rate would fall to this level, or lower, depending on Banxico’s intervention. This is something that you have to think about if you are a foreign investor with significant investments in USD in our country.

Banxico will have to stop our currency from appreciating further, to its detriment. The Brazilians introduced a tax to promote financial investment, and then later increased it to avoid greater appreciation of their currency.

M-bonds are also going to be at odds. On one level the Treasury Bond rate should gradually increase due to Fed’s intervention. On another level, we expect that with the reforms so close and with a possible improvement in Mexico’s sovereign debt rating by the rating agencies, the spread between M-Bonds and Treasury Bonds should fall to around 300 basis points. But in the process we could see a greater flattening of the curve and, of course, we cannot rule out that during some periods we will see pressure in the markets such as, for example, with the difficult negotiation taking place in the US Congress over the problem of the country’s debt and fiscal deficit.

For further information please contact Mauricio Gonzalez: mgonzalezc@actinver.com.mx