The new governor who will take office in January, former Secretary of the Treasury Arturo Herrera – a longtime ally of President Andrés Manuel López Obrador – hinted at his dovish lean on two occasions last month, despite annual inflation running high. around 6%, double the bank’s target. He would join two other “dovish” members of the five-person board who disagreed with Banxico’s rate hike in June, a split decision that took analysts by surprise.
“We are running the risk that Mexico is entering a new regime, a new environment in which inflation is higher,” said Manuel Sánchez, a member of the central bank’s governing board between 2009 and 2016 known for his stance ” hawkish ”. Some monetary policy makers have “an apparent willingness to cut, a bias to always lower rates.”
The change has not gone unnoticed in the bond market. Investors are betting that Banxico will allow inflation to be more than one percentage point above its annual goal of 3% for the next five years. And they are increasingly asking the government to sell them bonds that protect them against rising prices. In his view, the rate hike cycle that policy makers started in late June – a turnaround from a cut just four months earlier – will turn out to be too little, too late.
This is a sea change for an institution long revered as one of the most cautious monetary authorities in the developing world, dominated by economists with a hawkish view of the world created by the banking and currency crises of the 1980s and 1990s. . But it is in line with López Obrador’s promise to seek a governor “with a social dimension” when he decided not to renew Alejandro Díaz de León for a second term at the helm of Banxico.
“The change we’re seeing is a board that puts a little more weight on growth than just inflation and global financial conditions,” said Gabriel Tenorio, a strategist at Bank of America Corp. in New York.
Mexico is part of a broader trend that is spreading particularly in the developed world, where policymakers have been cutting interest rates while taking more “dovish” and growth-friendly stances amid the pandemic of covid-19.
Worldwide, a staggering $ 12 trillion in government debt has negative nominal returns. And in the United States, where interest rates are near zero and the Federal Reserve is buying $ 120 billion worth of bonds a month, yields hit a record low last month after accounting for inflation.
However, things are more complicated in emerging markets, where investors have punished countries that they believe have gone too far to tolerate inflation. Turkey’s central bank chairman Sahap Kavcioglu has kept the interest rate unchanged at 19% since he was appointed in March. In Brazil, policy makers raised interest rates by one percentage point this month and signaled another hike of the same magnitude next month.
Mexico has been taking a slower approach to tightening. After a rise of a quarter point in June, the central bank is likely to increase borrowing costs to 4.5% this Thursday. Economists surveyed by Citibanamex expect Mexico to close the year at 5% at the reference rate, still below inflation.
The central bank officials themselves estimate that a neutral rate would be between 1.8% and 3.4% after discounting inflation, that is, at least 7.6% if the current pace of price increases is taken into account. Tenorio believes that the neutral rate should be in the lower part of that range.
Proponents of a “hawkish” stance say Mexico can withstand slightly higher inflation if it stimulates economic growth, particularly the kind that would help lower-paid workers move up the ladder. They argue that while the bank’s more conservative stance has helped prop up the currency and limit price increases, it has also exacerbated inequality and poverty.
In an interview with Bloomberg Television last month, Herrera said the recent rise in consumer prices in Mexico appeared to be related to temporary factors. López Obrador himself has oscillated between wanting lower rates to boost growth and pushing to control inflation.
The central bank’s press office declined to comment.
Board divisions
Banco de México has not completely abandoned its hawkish roots. After all, it did raise rates in June, and the swap markets are pricing in increases totaling nearly 100 basis points between now and the end of the year.
López Obrador’s first appointed board member, Jonathan Heath, surprised Banxico watchers by backing the June hike after showing looser monetary policy stances during his first two years in office. Heath’s change left the other two members displaced by AMLO, Gerardo Esquivel and Galia Borja, in a divergent minority, with Esquivel harshly criticizing the increase.
Investors seek protection. Since late March, Mexico’s inflation-linked bonds, known as udibonos, have outperformed fixed-rate instruments by more than 3 percentage points. As demand increases, officials will raise the percentage of inflation-linked bonds to 20% of local offerings this quarter, from 12% in the previous three months.
“The market continues to view Banxico as a reluctant riser,” said Patrick Esteruelas, head of emerging markets research at EMSO Asset Management in New York.
For now, all eyes are on Herrera for new indications of what is to come for the central bank as the economy emerges from the worst contraction in nearly a century. His arrival could tip Banxico towards a more “dovish” approach by aligning with Esquivel and Borja.
“There is a great judge out there, which is the financial markets,” said Alonso Cervera, chief economist for Latin America at Credit Suisse Group AG. “If the markets perceive that the central bank is being too ‘dovish’ when it shouldn’t be, they will punish the peso and punish rates and the yield curve will shift.”