Rabobank strategist Molly Schwartz and Christian Lawrence discuss Mexico’s rates outlook after Banxico held the overnight rate at 6.50%. They note upside risks to inflation, market pricing for more than 100bp of hikes over a year, a pronounced steepening of the Mexican yield curve versus the US, and resilient foreign ownership of Mbonos and Cetes.

Banxico stance, curve steepening, carry dynamics

"Banxico released its decision on September 24 to hold the overnight target rate at 6.50%, in line with expectations. However, what diverged from expectations for some was the insistence in the Monetary Policy Statement that Banxico would not necessarily anchor its future decisions on the path of the Federal Reserve, and the removal of the statement that the Bank “estimates that it will be appropriate to maintain the reference rate at its current level.”"

"While the Statement gives Banxico wiggle room to move rates in either direction, the assertion that we could see Banxico-Fed policy divergence has led some investors to speculate about a further reduction in the Mexico-US rate differential and an unwind of the carry trade. A large-scale carry trade unwind has not been fully reflected in the current USD/MXN exchange rate or CFTC non-commercial speculator positions, though the carry trade has evidently lost some appeal in recent weeks."

"The risk to Banxico’s inflation outlook, and therefore its rate outlook, is skewed to the upside. While we maintain our view that Banxico will hold the overnight policy rate at 6.50% through year-end, market-implied pricing suggests investors are positioned for a hike within the next three months and more than 100bp of hikes in one year."

"Looking ahead, we favour continued narrowing of the MX-US 10-year spread, but the pace is likely to slow relative to recent price action. At the front end of the curve, we hold the same view, but there is likely more juice to squeeze than at the long end."

"The ownership picture is sturdier than the price action implies. Non-residents added about MXN 42bn of government paper in the first half, taking their holdings to roughly MXN 1.78tn, or a bit over 11% of the total, with the increase split between Mbonos and Cetes."

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