Mexico Goes From Fed Copycat to Latin America Wildcard Overnight

  • Mexico traders see widest rate gap with U.S. since 2014
  • Goldman says large dollar sale or even surprise hike possible

After six years of playing by the book, Mexico’s central bank chief is shedding his orthodox image.

Agustin Carstens went from predictable Fed copycat to Latin America wildcard when the central bank shocked markets last week by unexpectedly raising interest rates by a half-percentage point in a unscheduled board meeting. Traders are now betting Carstens will keep raising borrowing costs even if the Federal Reserve doesn’t, sending the gap between implied rates in the U.S. and Mexico to a two-year high.

“It was a bold move,” said Mike Moran, the head of economic research for the Americas at Standard Chartered Plc in New York. “He’s breaking with previous norms to suit his purposes.” 

Over the past year, policy makers including Carstens had repeatedly signaled they’d raise borrowing costs when their U.S. counterparts did in a bid to prevent the peso from weakening further by preserving Mexico’s interest rate advantage. But recent turmoil in global markets forced Carstens to rethink that approach as a tumbling currency threatened to spur inflation in Latin America’s second-biggest economy.

The gap between implied one-year interest rates in U.S. and Mexico widened 43 basis points, or 0.43 percentage point, since Feb. 16, the day before Carstens’ surprise move, to 3.9 percentage points, the most since February 2014. Swap contracts now show traders expect Mexico to raise its benchmark lending rate by as much as 75 basis points to 4.5 percent within a year, while there’s about a 50-50 chance the Fed will make any move at all.

Ricardo Medina, a spokesman for Mexico’s central bank, declined to comment on expectations for monetary policy.

Policy Coordination

In a rare coordinated announcement on Feb. 17, Carstens and Finance Minister Luis Videgaray said borrowing costs would increase and that the government would cut spending by more than 132 billion pesos ($7.3 billion). Carstens also said the central bank would sell greenbacks directly to banks whenever needed to support the currency, a departure from years of public auctions based on pre-determined triggers.

Mexico has a “full set of tools on the monetary and currency side to intervene when necessary,” Videgaray told Bloomberg News in an interview on Friday.

Goldman Sachs Group Inc. chief Latin America economist Alberto Ramos said that while another rate hike in between meetings is "certainly possible," a large dollar sale is more likely.

Since he took office in January 2010, Carstens’s five-member board had raised rates only once before last week. Before his first decrease in March 2013, Mexico had left borrowing costs on hold for more than three years, the longest for any so-called Group of 20 nation.

The bank’s “shock-and-awe” tactic last week was designed to discourage investors from using the peso as a hedging tool, which undermines the currency, said Alejandro Silva, a partner at Silva Capital Management in Chicago.

So far it’s working. The peso has gone from being the world’s worst major currency in 2016 to the best of the past week. It has gained 3.7 percent since Feb. 16, after sliding 8.9 percent this year before then. The currency fell 0.4 percent Wednesday to 18.284 per dollar at 10 a.m. in Mexico City.

“Extraordinary circumstances require extraordinary actions,” Silva said. “They’re more than justified.”

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