August 22, 2019

Mexico Warms Up to 'Global Easing'

Mexico's central bank cut its key interest rate by 25 basis points last week to 8 percent from a 10-year high. This was the first rate cut in five years and the move has significance for a couple of reasons.

There was no sign of Mexico cutting rates until July. The Bank of Mexico, known as Banxico, had raised rates 15 times over the past three years because of high inflationary pressures and weakening of the Mexican peso. The central bank's decision to switch gears into monetary easing mode transpired rather suddenly. It was a split 4 – 1 decision, so clearly not a slam dunk either.

It's a similar story with the U.S. Federal Reserve, where the central bank may have given in to market and political pressures. The financial market started to warm up to the rate-cut idea in July after the Fed turned dovish. Late last month, Mexico's President Andres Manuel Lopez Obrador said that while he respects the central bank's independence, he'd also like to see Mexico cut rates to boost growth.

Mexico has now joined the worldwide chorus of the “race to the bottom” on interest rates. Since the beginning of this year, global central banks have rushed to cut rates. These countries include India, Russia, Brazil, Indonesia, South Africa, China and of course, the U.S. Countries that already have negative interest rates such as Europe, Japan and Switzerland are also talking about further easing.

Banxico is now willing to take a risk on inflation and focus more on economic growth. Core inflation in Mexico still remains high, above its 3 percent target. But the country's high interest rate, one of the highest in the world, has stalled economic growth, which has been about half of that of other emerging-market countries at about 2.5 percent. There is an urge to revamp the economy faster.

Even so, Mexico's peso has not weakened and is trading around the same level as before the cut, despite weaker economic numbers and aggressive cuts expected ahead. Dollar-peso volatility has not spiked, suggesting no disruptive markets ahead either.

Mexico's currency is holding its value because of the ''carry trades,'' a trading strategy whereby speculators buy the currency of higher yields, and are willing to take the currency risk for the richer return. Currently there is an insatiable appetite for yield by international investors around the world, telling us that monetary policy of one country may depend on other countries' interest rate levels. This appetite for yield is not confined to emerging market countries, but is also seen even in developed economies, such as the U.S. and the EU. where we've recently seen the US Treasury yields collapse.

My View: So what does this tell us? As long as the liquidity glut is there and inflation is indeed contained, global interest rates will be suppressed for a long time, in pursuit of pumping up global economic growth first.

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