Mexico's central bank cut the overnight rate to by 25 basis points this morning to a record low of 3.75 percent. The bank's statement cited subdued growth in both the EM countries and the US and Europe, as well as an environment of rising global rates in face of an expected shift in the stance of US monetary policy. Given the weaker than expected growth this year, the bank seems especially concerned about the rise in medium and longterm rates, even in the Peso denominated money market, driven entirely by an "anticipation in of a reduction of asset purchases by the Federal Reserve," in the banks own words translated from the Spanish. Mexico is not ready to raise rates, and therefore felt compelled to do something on their end by easing conditions on the local money market with a rate cut. The bank also tried to calm the FX market, directly mentioning the volatility in EM currencies. The bank cited that inflation expectations remain unaffected by swings in the exchange rate, but remains committed to monitoring the situation. The bank also applauded strengthening public finances, and the low risk premiums Mexico pays to borrow money compared to other emerging markets. In general, the bank expects inflation to remain subdued and growth to strengthen in 2014. However, it remains concerned that external factors, such as rising global rates may derail the local recovery. Therefore, the bank ended its statement with a commitment to monitor "inflation, the evolution of economic activity, and its own policy stance vis a vis other central banks with the ultimate objective of continuing to achieve its inflation target of three percent." Although the bank covered all the bases, including growth, inflation, and exchange rate volatility, the bank, inflation and price stability remained clearly in focus despite the fact that today's statement came with an easing of policy. This mixing of a somewhat hawkish statement with an easing of policy left the MXN unchanged after the announcement of the cut. Specifically, the USD/MXN spiked briefly up to 13.35 from around 13.24 in the minutes after the announcement, only to fall back down to around 13.1855 by 4:45 PM GMT. For the day, the Peso is up despite the rate cut.
As far as outlook for the MXN, the market seems directionless. Weaker than expected NFP numbers sent the dollar down this morning against everything, as expectations of the Fed tapering this month weakened. Again, the fundamentals of the Mexican economy, despite weakening substantially this year along with US, remain strong. Both north and south of the border, growth has slowed as governments have tightened their belts, but consumer confidence remains at five year highs. Major reforms to the energy sector are being debated this month in the Mexican Congress, and is widely expected to pass. In light of recent developments, I am raising my year end target for USD/MXN to 12.70. I expect the peso to regain its footing after tapering by the Fed becomes fully priced in. The FOMC meeting later this month is the next big event and should set expectations for the rest of the year. On the upside, 13.46, this year's high, remains as an area of critical resistance for USD/MXN. The pair failed to breach this level a few days ago and today's rate cut ironically has it moving in the opposite direction. In short, investor appetite remains strong for the peso, as evidenced by today's activity and the fact that this summer's second round of EM volatility was much kinder to Mexico than to other EM currencies such as INR, TRY, ZAR, BRL, and even smaller regional stars like the Thai Baht (THB) and Peru's Nuevo Sol (PEN).I continue to remain cautiously optimistic, for now.
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