Heading into today's rate cut decision by the Mexican Central Bank, analysts were nearly unanimous, with 20 out of the 22 analysts expecting a 50bpcut, 1 a 75bp cut, and the remaining one 100bp. The majority was right, with the Bank of Mexico - seeking to stimulate the Mexican economy from its worst recession in recent history - cutting rates again to 5.50% from 6.0% in a unanimous decision, even though Goldman had assessed "a 40% probability of a larger 75bp-100bp cut given the sharp deterioration of the growth outlook, worsening business confidence and PMIs, decelerating consumer credit and formal job creation, and below-target headline, services and non-food core-goods inflation."
And with that, the highest yielding currency in LatAm (aside for the occasional banana republic) just became even a little bit less attractive for carry traders.
Explaining the rate cut, the central bank said that it took "into account the referred risks for inflation, economic activity and financial markets, majorchallenges arise for monetary policy and for the economy in general. Considering the room for maneuvering that on balance monetary policy has as a result of these implications, and with the presence of all its members, Banco de México’s Governing Board decided unanimously to lower the target for the overnight interbank interest rate by 50 basis points to a level of 5.5%."
Commenting on the decision, Banxico said that "the challenges for monetary policy posed by the pandemic include both the unprecedented impact on economic activity as well as those associated with the financial shock that we are currently facing. As for the risks to the foreseen trajectory of inflation, the most important to the downside are a significant widening of the negative output gap and the effects of the fall in energy prices. To the upside, a greater or more persistent depreciation of the peso and possible disruptions to chains of production and distribution of certain goods and services. In this context, the balance of risks for inflation remains uncertain."
The central bank also said that "available information shows that economic activity in Mexico contracted significantly during the first quarter of the year, incorporating the effects associated with the pandemic in March, which affected the production of goods and services considerably. Although the magnitude and duration of the effects of the pandemic are still unknown, these are expected to intensify during the second quarter, and to result in a significant contraction of employment. Slack conditions thus continue to widen considerably, in a context in which the balance of risks for growth is significantly biased to the downside."
Since the decision was widely as expected, the MXN was virtually unchanged trading at around 24.25 after the announcement.
Goldman justified the 50bp rate cut with the following recent developments:
- The deep recession and declining commodity prices are starting to bend the inflation curve down, as seen by the impact on tourism-related services, airfares and gasoline prices. The expectation of a very deep recession in 2020 should reduce pricing power and limit the pass-through from a weaker MXN to higher final consumer prices. Finally, lower Dollar commodity prices should also contribute to keep inflation in check.
- Annual headline inflation moderated to a well below inflation target band 2.15% in April (close to the 2% lower limit of the target range), and core inflation eased to 3.50% (from 3.60% in Mar), with core-services inflation declining to a low 2.84% (down from 3.35% in Mar) and the first sub-3% print in 40 months). However, on a less benign note, core-goods food/tobacco/beverages inflation accelerated to a high 5.78% yoy in April, but core-goods ex-food/tobacco/beverages (component mostly correlated with the real business cycle) declined by 20bp to a further below-target 2.34%.
- The performance of the economy continues to disappoint and the output gap to widen. Sequentially, real GDP recorded no growth in 4Q19, and average sequential quarterly growth during the last seven quarters has also been zero. GDP growth.
- According to the 1Q2020 flash estimate, real GDP declined by a larger than expected 1.6% qoq sa (-2.4% yoy sa) reflecting the early impact of the Covid pandemic on both domestic and external demand.
- Leading indicators point to a very large drop in activity in 2Q: ANTAD reported that sales declined by 24.5% yoy in April, auto production declined 98.8% yoy and auto sales retrenched 64.5% yoy.
- Sentiment continues to deteriorate. Business confidence declined sharply in April (-6.2pt; the seventh consecutive monthly decline) with the index now sitting deep within pessimist territory (37.4). The Manufacturing and Services PMIs also fell sharply in April, and are now at the lowest levels on record.
- Consumer credit growth decelerated further: to 0.0% yoy in real terms, down from 1.1% yoy in Feb and 2.4% yoy in Dec. However, corporate credit growth accelerated to 10.0% yoy in March, from a minor 0.4% yoy in Feb and 9.1% yoy a year ago), likely a reflection of increasing credit demand by corporates given the covid-related hit to cash-flows and, on the supply of credit side, the effect of the recent central bank measures to boost liquidity and support credit origination, particularly to SMEs.
- Expectations for 2020-21 headline inflation improved and the outlook for the economy worsened further. According to the April central bank survey, the median expectation for headline inflation in 2020 declined to 2.90%, from 3.64% and for 2021 declined by a minor 1bp, to 3.50%. The median expectation for core inflation in 2020 declined by 16bp, to 3.34%, and for 2021 by 45p, to 3.44%. The median expectation for real GDP growth in 2020 declined to -7.1% (from 3.5%) and for 2021 rose slightly to 2.20% (from 1.70%).
- The median market expectation for the policy rate at end-2020 declined to 5.00% (from 5.50%), and for end-2021 declined to also 5.00% (from also 5.50%). n The MXN/USD has been trading well: broadly at the same 23.4 level ahead of the April 21 inter-meeting 50bp rate cut.
- Formal job creation continues to decelerate: according to the social security ministry database (IMSS), formal employment growth decelerated to an all-time low -2.21% yoy in April, from +0.66% in March and 1.54% yoy in Feb. Formal employment declined by 555 thousand from March and 451 thousand from a year ago. On a quarterly basis, formal job creation decelerated to 0% in the 3-months ending in April, from 1.26% yoy in 1Q2020, down from 1.74% yoy in 4Q19.