You could have won a lot of money had you wagered that the most startling market driver last Friday would not have been the US non-farm payroll report, but rather the shocking 50 bps cut from the Central Bank of Mexico.
Of the 20 panelists in the Bloomberg Banxico survey, precisely zero called for anything other than rates on hold at 3.50%. Although it is true that Mexican CPI has fallen a percent from its recent highs, at 3.5% it is close to the levels where it's troughed over the past few years. Perhaps more importantly, cutting last week took the real policy rate clearly into negative territory, back towards the lowest levels in the history of modern Mexican monetary policy.
USD/MXN, which was breaking down nicely after the most in-line employment data Macro Man can ever recall seeing, performed a swift volte-face to close higher on the day. Coming the day after the ECB's howitzer blast, the Banxico cut could perhaps be seen as the latest shot fired in the by-now tiresome currency wars.
If so, it is not altogether clear that Banxico's on to a winning strategy. Over the long run, the correlation between USD/MXN and real policy rate differentials has been tenuous at best, although the relationship has strengthened somewhat since the crisis.
Nevertheless, the current policy differential has still generally been consistent with a stronger MXN, though the relationship is weak enough that you probably wouldn't want to hang your hat (or bet your P/L) on it.
Trying to use external imbalances as an exchange rate determinant is even worse, alas. Thanks in large part to its oil reserves and the secular commodity bull market, Mexico's current account balance as a % of GDP has been better than that of its northern neighbour since the end of the last century. In the intervening period, the MXN has weakened pretty steadily. Indeed, one suspects that the persistent weakening of the MXN in nominal terms has played rather a large part in maintaining Mexico's current account "superiority", and that a constant nominal or even real effective exchange rate would leave the chart below looking somewhat different.
So what are we to make of Mexico, then? It's been a market darling for what seems like forever, and as a currency trade at least that's been rather difficult to monetize. Indeed, as has been the case in many other assets this year, positioning has been of paramount importance in determining market pricing. Although one certainly hopes that the bad old days are behind us, price action in Jan-Feb during the "Fragile Five Fiasco" was certainly not encouraging.
Although price action in rates was, if anything, worse than in FX, at least fixed income should benefit from low domestic rates. Indeed, while the MXN was struggling after the cut, 10y TIIE swaps put in an eye-watering 35 bp rally. While it may be difficult to receive rates after such a move, doing so on any sort of pullback (say to 6.25% in 10y) may make sense. After all, the carry/rolldown is pretty attractive (the 28 day TIIE floating rate is some 275 bps below the 10y coupon, even after Friday's rally), and there's plenty of room to reach last year's lows.
Of course, the major hurdle to that is the beta to Treasuries, which remains uncomfortably high. Nevertheless, we are entering a seasonally positive period for Treasuries, so that could assuage some of the worst fears. At the very least, receiving TIIE could be seen as a positive carry hedge to shorts in eurodollars, which continue to look rich over many parts of the curve.
One can only hope that Montezuma will be pleased and doesn't seek any monetary revenge....
Of the 20 panelists in the Bloomberg Banxico survey, precisely zero called for anything other than rates on hold at 3.50%. Although it is true that Mexican CPI has fallen a percent from its recent highs, at 3.5% it is close to the levels where it's troughed over the past few years. Perhaps more importantly, cutting last week took the real policy rate clearly into negative territory, back towards the lowest levels in the history of modern Mexican monetary policy.
USD/MXN, which was breaking down nicely after the most in-line employment data Macro Man can ever recall seeing, performed a swift volte-face to close higher on the day. Coming the day after the ECB's howitzer blast, the Banxico cut could perhaps be seen as the latest shot fired in the by-now tiresome currency wars.
If so, it is not altogether clear that Banxico's on to a winning strategy. Over the long run, the correlation between USD/MXN and real policy rate differentials has been tenuous at best, although the relationship has strengthened somewhat since the crisis.
Nevertheless, the current policy differential has still generally been consistent with a stronger MXN, though the relationship is weak enough that you probably wouldn't want to hang your hat (or bet your P/L) on it.
Trying to use external imbalances as an exchange rate determinant is even worse, alas. Thanks in large part to its oil reserves and the secular commodity bull market, Mexico's current account balance as a % of GDP has been better than that of its northern neighbour since the end of the last century. In the intervening period, the MXN has weakened pretty steadily. Indeed, one suspects that the persistent weakening of the MXN in nominal terms has played rather a large part in maintaining Mexico's current account "superiority", and that a constant nominal or even real effective exchange rate would leave the chart below looking somewhat different.
So what are we to make of Mexico, then? It's been a market darling for what seems like forever, and as a currency trade at least that's been rather difficult to monetize. Indeed, as has been the case in many other assets this year, positioning has been of paramount importance in determining market pricing. Although one certainly hopes that the bad old days are behind us, price action in Jan-Feb during the "Fragile Five Fiasco" was certainly not encouraging.
Although price action in rates was, if anything, worse than in FX, at least fixed income should benefit from low domestic rates. Indeed, while the MXN was struggling after the cut, 10y TIIE swaps put in an eye-watering 35 bp rally. While it may be difficult to receive rates after such a move, doing so on any sort of pullback (say to 6.25% in 10y) may make sense. After all, the carry/rolldown is pretty attractive (the 28 day TIIE floating rate is some 275 bps below the 10y coupon, even after Friday's rally), and there's plenty of room to reach last year's lows.
Of course, the major hurdle to that is the beta to Treasuries, which remains uncomfortably high. Nevertheless, we are entering a seasonally positive period for Treasuries, so that could assuage some of the worst fears. At the very least, receiving TIIE could be seen as a positive carry hedge to shorts in eurodollars, which continue to look rich over many parts of the curve.
One can only hope that Montezuma will be pleased and doesn't seek any monetary revenge....
3 comments
Click here for commentsDespite the surprise rate cut, the move in MXN was pretty tame IMO, just like it was last year when they did the same thing. The market love Pena Nieto, even though the reforms have been slow, they are in the pipeline. The carry in the 10 year is attractive, interesting note.
ReplySince we are on a global macro tilt, I would say the biggest macro story over the past month is India. Equity markets there above election highs. But will reforms push down inflation and thus can you play the FX and rates markets or just stick to Momo in the stock market. I guess the trade is to now buy expectations of large reforms and then sell closer as they arrive and probably have less current impact than the market expects. I'm looking for a little pull back but not sure we are going to get one.
You could also have won a lot of money had you wagered that the SP500 will go up almost every day. Since the Fed have your back on this trade it surprises me that more people aren't in it. Easiest money I ever made.
ReplyCan't see Mexico getting out of the group, MM. One of the worst teams to represent El Tri in many years and very lucky to be in Brazil at all in my opinion. One wonders how the mighty heavyweights of CONCACAF - Costa Rica, US, Honduras and Mexico are going to fare at the big tournament. It's quite possible that not one of these teams will win a game. No hate mail, please....
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