Currency War Hits Mexico as Carstens Signals Rate Cuts
Central Bank of Mexico Governor Agustin Carstens
Andrew Harrer/Bloomberg
Central Bank of Mexico Governor Agustin Carstens signaled during a meeting with economists in New York that he would consider cutting rates should the peso keep gaining, according to analysts who attended the meeting.
Central Bank of Mexico Governor Agustin Carstens signaled during a meeting with economists in New York that he would consider cutting rates should the peso keep gaining, according to analysts who attended the meeting. Photographer: Andrew Harrer/Bloomberg
The peso’s biggest rally on record may prompt Mexico’s central bank to cut interest rates next year to boost exports after other Latin American policy makers raised borrowing costs to cool their economies.
Governor Agustin Carstens signaled during a Nov. 2 meeting with economists in New York that he would consider cutting rates should the peso keep gaining, according to analysts from Barclays Capital, Deutsche Bank AG and UBS AG who attended the meeting. The bank may lower borrowing costs a quarter percentage point to 4.25 percent by March, Mexican futures trading show.
Foreign investment in short-term Mexican notes known as Cetes has risen more than six-fold since the end of 2009 as investors looked for alternatives to near-zero interest rates in the U.S. and Europe. Inflows almost doubled last month to 70.4 billion pesos ($5.78 billion) as international investors anticipated the Federal Reserve would pump additional liquidity into the U.S. economy. China said this week the Fed’s decision to purchase $600 billion in U.S. Treasuries threatens to “shock” emerging markets with “hot money.”
“Mexico runs the risk of being slammed by the markets,” said Alonso Cervera, a Latin American economist at Credit Suisse Group in Mexico City who attended the meeting with Carstens in New York. “If there’s a rally in the peso, we shouldn’t be surprised if they choose to cut rates.”
Defending Exports
In seeking to curb the peso’s 7.7 percent advance against the dollar over the past 10 weeks with a rate cut, Carstens would be defending his country’s exports from what Brazilian Finance Minister Guido Mantega has called a global “currency war,” said Jimena Zuniga, an economist at Barclays.
“If the central bank perceives it is left alone in the currency war and the peso is losing competitiveness, then the central bank might consider measures including using monetary policy to discourage inflows,” said Zuniga, who was at the New York meeting with Carstens.
The yield on Mexico’s 9 percent bond due in 2012 dropped 10 basis points the day after Carstens’ meetings with economists and investors.
Still, Standard & Poor’s doesn’t see changes in Mexican interest rates next year, Lisa Schineller, director for Latin America, said at the Bloomberg Mexico Economic Summit today in Mexico City. Sergio Luna, chief economist for Citigroup Inc.’s Banamex unit, also said he didn’t expect a change in rates.
Domestic Demand
Mexico’s domestic demand remains weaker than regional peers including Brazil and Chile even as stronger exports to the U.S. have led the central bank to forecast 5 percent growth in 2010 after the economy contracted 6.5 percent last year, the worst slump since 1932. While consumer confidence and retail sales have increased, and unemployment fallen, they remain below levels before the Sept. 2008 collapse of Lehman Brothers Holdings Inc.
Mexico’s IPC index of 35 stocks has climbed 13 percent this year, exceeding the 4 percent gain for Brazil’s Bovespa index.
The March 2011 futures contract for the 28-day interbank rate, known as TIIE, fell 23 basis points since the end of September to 4.74 percent Nov. 8, suggesting policy makers may cut borrowing costs 25 basis points. The futures rate rose to 4.77 percent yesterday. In the past five years, the spread between the TIIE and benchmark has averaged 38 basis points.
The peso has gained 6.7 percent this year, on pace for the biggest annual rally on record. The currency rose 0.3 percent to 12.2667 per U.S. dollar at 12:27 a.m. New York time.
Currency Gains
Only the Colombian peso has gained more among major Latin American currencies, rising 10 percent since Dec. 31. A stronger currency hurts exporters by making their goods become more expensive in dollar terms.
Countries from Brazil to Thailand to Colombia are imposing levies on foreign capital, ending tax exemptions for foreigners or stepping up dollar purchases in the currency market. Carstens criticized such moves in an Oct. 27 radio interview.
“We would try to avoid falling into these circumstances, although you can never discard all possibilities,” Carstens said. Currency wars are “very destructive,” he told Radio Formula.
The central bank declined to comment on Carstens’s meeting last week with economists.
Brazil’s 10.75 percent benchmark rate and Mexico’s 4.5 percent rate are luring foreign investors seeking to bolster returns on their cash. Banco de Mexico has kept the benchmark interest rate unchanged since July 2009.
Inflation Forecasts
Inflation, while quickening to 4 percent in October, is below the bank’s forecasts, and policy makers have said the economy remains vulnerable to the slowdown in the U.S., which buys 80 percent of Mexico’s exports.
On Oct. 27, the central bank changed its 2011 inflation forecast of 2.75 percent to 3.25 percent to an estimate of 3 percent plus or minus one percentage point. For Morgan Stanley, the change gave the central bank “room to justify a potential rate cut,” according to a Nov. 1 report.
Foreign investment in Cetes, zero-coupon bonds with a maturity of as long as two years, almost doubled to 70.4 billion pesos on Oct. 27 from 37.7 billion pesos a month earlier, according to the central bank’s website. Foreign investment in Cetes was 11.6 billion pesos at the end of 2009.
“This is the first sign of speculation, which is what the central bank wants to avoid,” Cervera said. “It’s money that won’t be there to help you fund 10-year mortgages or long-term investment projects.”
Bucking Trend
A rate cut would set Mexico apart from Brazil, Chile and Peru, where policy makers raised rates after the global financial crisis ended. In Colombia, economists at Banco Popular SA and Interbolsa SA have speculated the central bank may reduce its rate from 3 percent after consumer prices fell in October.
Deutsche Bank expects the central bank to lower the interest rate by a half point at its final policy meeting of the year on Nov. 26.
“In the meeting with Carstens there was nothing that could make us doubt our call,” Mauro Roca, an economist at Deutsche Bank, said in a telephone interview from New York.
Deutsche is one of only two of 23 firms polled in a Nov. 4 survey by Citigroup Inc.’s Banamex unit predicting the bank’s next move will be a rate reduction.
Banco de Mexico last month cut its inflation forecast for the next two quarters, saying the country was experiencing only moderate wage increases and limited external pressure on prices.
The central bank won’t reduce borrowing costs unless it’s certain that foreign investment will keep pouring in, Carstens said at the New York meeting, according to Rafael de la Fuente, a senior economist for Latin America at UBS.
“The message is that they are not comfortable at all with the peso’s appreciation,” said Bertrand Delgado, an economist at Roubini Global Economics LLC in New York, who didn’t attend the gathering. “This is a form of verbal intervention.”
To contact the reporter on this story: Jens Erik Gould in Mexico City at jgould9@bloomberg.net Andres R. Martinez in Mexico City at amartinez28@bloomberg.net
To contact the editor responsible for this story: David Papadopoulos at papadopoulos@bloomberg.net
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