Mexico— Primary CETES Auction Showed Mixed Results. The 10yr M-Bond Yield Increased by 10bps. MXN Weakened Sharply
In the primary CETES auction, the 28dys and 336dys CETES declined by 9bps and 10bps to 7.07% and 7.14%, respectively. However, the 91dys and 175dys increased marginally by 1bp and 4bps to 7.29% and 7.1%, respectively. This continues to suggest that market participants already have discounted another rate cut of at least 50bps in February. Concurrently, in the M-Bond public sale, the 10yr bond yield went up by 25bps to 8.24% as risk appetite deteriorated.
In our view, there is a 75% probability that Banxico will likely cut the reference rate by 50bps during the February 20th meeting; however, we do not discard the possibility of a 75bps cut. Overall, economic data indicates that the economy is under intense recessionary pressures and that inflation and inflation expectations are normalizing. Nevertheless, strong weakening forces on the MXN are still a concern. Indeed, over the last two sessions, the local currency has weakened significantly (2.4%) in response to elevated risk aversion mainly because of investors’ concern that the new US bank rescue plan will not be enough to shore up economic growth, as well as the fact that Banxico did not intervene in the local FX market. Moreover, it did not help that the Fitch rating agency stated that it will monitor Mexico’s currency intervention, the magnitude of the economic contraction, and the impact of the downturn on the fiscal and external accounts to decide whether to cut debt ratings. Under current conditions, it is likely that the MXN will test again the MXN 14.7 level (MXN 14.3 to MXN 14.7 range) in the upcoming days.
The central bank survey suggests that headline inflation in February will likely print 0.89% m/m (BD 0.96% m/m), which will be lower than the 1.55% m/m registered in Feb. 08, but above the 0.58% m/m reported in Jan. 09. Concurrently, ex-food inflation is expected to print 0.65% m/m (BD 0.59% m/m). Moreover, analysts adjusted their headline inflation expectations down to 5.15% from 5.28% (BD 4.84% from 4.98%) by year-end 2009, thus reinforcing the view that the central bank will comply with the inflation target for this year (4.5% to 5.5%). Finally, inflation forecast for the end of 2010 improved significantly to 4.38% from 4.65% y/y (BD 4.4% from 4.49% y/y).
Regarding the COP, analysts expect the local currency to be about COP 2440.85 by the end of February (BD COP 2,480). Of importance, survey participants changed dramatically the COP forecast for the end of 2009 to COP 2464.1 from COP 2,368.5 (BD COP 2,445 from COP 2,371.6). Finally, participants now expect BanRep to cut the ON rate more aggressively by slashing 50bps to 8.5% (BD 8.5%) during the February meeting, and to 7.5% by the end of June (BD 7%) and to 7.25% by the end of 2009 (BD 6.5%). Previously, analysts have expect the ON rate to be about 8.35% by the end of June (BD 7%) and 7.9% by the end of 2009 (BD 6.5%).
Overall, declining inflation expectations and rapid widening of the output gap indicate that the central bank will likely continue easing the monetary policy rate speedily. The sharp weakening of the COP remains a concern and it will likely avoid the CB from easing rates more aggressively than the 50bps expected by market participants this month.