The press conference of the president of the Fed, Jerome Powell, which took place on November 2, immediately after the organism decreed an increase of 75 basis points in its reference rate, will have an impact on the street of 5 of Mayo and Eje Central, in Mexico City, headquarters of the Bank of Mexico (Banxico).
Jerome Powell has put the Mexican central bank and, possibly, other banks in the world at a crossroads.
The press conference had the markets and the financial world in general on edge, and it was no wonder. The main indicators on Wall Street initially reacted positively after the upward adjustment of 75 basis points in the Fed rate was announced, as the consensus expected, but with the press conference the mood changed, what happened? Why will Banxico be in a dilemma for the next few months?
From the joy to the well
The president of the Fed began his conference with some details about what he called “a possible brake on interest rate hikes”; he first warned with a phrase that he has mentioned on several occasions that “there is still a way to go”, referring to the fact that there is still time before considering that the increases have reached the ceiling. He also warned that this level will be higher than expected in September.
In September the Fed forecast that the ceiling level would be between 4.35 and 4.5 percent.
In that sense, he warned that the most important question is not the pace that the escalation will continue, but how far the Fed is going to raise interest rates?
But, without a doubt, what shook the market, rebounded in the stock markets causing them to fall sharply and put our central bank and probably several others at a crossroads, was what Jerome Powell pointed out near the end.
Two sentences were devastating and leave no room for doubt about what the Fed will do in the coming months; Powell’s first sentence was as follows: “economic activity data indicate that rates will have to be raised to a higher level than initially expected to stabilize inflation“.
In other words, the central bank of the United States announces that interest rates in that country are going to rise beyond the maximum 4.5 percent that it estimated in September, but how much? That is the big question that Powell himself said he did not have an answer for the moment, possibly next December or at the beginning of 2023 they could estimate a new “ceiling” in the reference rate.
Higher rates are bad news for credit markets, for economic activity in general and, of course, for the stock markets.
The second sentence, perhaps the one that most struck the mood of investors and darkened the panorama even more, was the following:
“If we go too far with tightening, we could turn around and use our tools with all the force necessary to revive the economy. But if we fall short, inflation may stall and even end up higher“.
In other words, the Fed in general and Powell in particular prefer to go too far by raising interest rates to levels that may even be excessive, rather than go short.
Namely, the ceiling for interest rates can be so high that it can even be excessivebut that does not worry the Fed, because it prefers that to leaving rates at a level that, over time, the evidence shows was insufficient.
Powell finished by noting that from his point of view he still considers it premature to stop the rate increase.
In short: The escalation in interest rates will still take a while; at the moment it is not known what a possible “ceiling” would be, and rates will rise as much as the Fed considers it, even if this level becomes excessively high.
the crossroads
Several analysis houses and private analysts, as well as even the deputy governor of Banxico, Gerardo Esquivel, have indicated that perhaps the country’s monetary body should stop keeping pace with the Fed’s rate hikesdue to the fact that Banxico initiated the upward adjustment of rates before the Fed.
In addition, the circumstances in Mexico suggest that the markets, especially the exchange rate, would not react negatively if Banxico stops raising rates and the spread between the two central banks (Fed and Banxico) narrows.
And the crossroads is a reality. Let’s suppose that the Fed places its reference rate ceiling at 5 percent, that means that with the current difference, Banxico should raise the rate to average levels of 11 percent. But if the Fed decides that its rate ceiling is higher, say at 6 percent, then Banxico’s rate would go up to 12 percent.
Economic theory says that the higher the interest rate, the less dynamic there will be in the economy.We have suffered it in other times. Today the projections speak of the fact that next year the activity in the Mexican economy will slow down (it will slow down), precisely due to the effect of the increase in interest rates.
Will Banxico follow the Fed to the end? Will it dare to challenge the markets hoping that the peso will maintain its relative strength and stop following the pace of the US central bank? Will it choose to play in favor of not slowing down the economy any further? hoping that the Fed succeeds in its monetary policy, reaches a ceiling in its rate and then resumes the cut? Will he break away from the Fed for the first time in the modern era?
Banxico will be at a crossroads for the next few months, rates in the country could rise excessively, it is already a fact that before the end of the year they will reach double digits, but following the Fed puts it on the same path: preferring to go too far in raising rates rather than go too short. The point is that the economy of Mexico and that of the United States are totally different, an excess in the increase in interest rates has much more serious consequences in our country.
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