When Mexico’s central bank, Banxico, and its Ministry of Finance surprised investors with coordinated policy actions last month, our emerging markets portfolio management team had just met with government officials and policymakers in Mexico. Our conclusions: Not only does Mexico continue to demonstrate sound fundamentals, but policymakers are also committed to providing a supportive macro framework, making Mexico truly a “rising star.”
On 17 February, Banxico hiked its policy rate by 50 basis points ‒ between scheduled policy meetings ‒ and announced that it will approach currency interventions in a discretionary manner to help support financial stability. Discretionary interventions create two-way risk for the peso, which had come under speculative pressure because of its high correlations to oil prices and equity markets and its relatively low cost of carry. At the same time, the Ministry of Finance announced plans to cut expenditures by 0.7% of GDP to help achieve its 3.0% fiscal deficit target for 2016.
On our research trip last month, we confirmed our view that Mexico’s fundamentals are relatively healthy despite the external pressures of falling oil prices, global growth concerns and the strong U.S. dollar. Moreover, Mexico’s commitment to maintaining fiscal prudence is as resilient as ever. Steady growth of 2.5%‒3% is below Mexico’s potential of around 3.5% but a healthier pace than in most of Latin America. And inflation remains benign: December’s 2.1% year-on-year pace was the lowest in Mexico’s history.
Modest growth and benign inflation typically make for a very positive combination for local bonds ‒ the “Goldilocks” scenario of “not too hot, not too cold.” They also typically suggest a dovish tilt to monetary policy. So why did authorities tighten both fiscal and monetary policy?
The answer is what makes Mexico stand apart from other emerging markets. As recent asset returns show, Mexico has not been immune to global headwinds: Falling oil prices have reduced fiscal receipts and foreign trade balances, while global uncertainty and a strong U.S. dollar have pressured Mexico’s peso lower. Mexico’s policy diligence signaled, then, that authorities will proactively fight these external pressures, and global shocks in general, to protect the country’s long-term credit quality ‒ an important development for investors.
Fiscal consolidation amid slowing growth cements Mexico’s commitment to maintaining public sector balances and showcases the strong coordination between monetary and fiscal authorities. Our GDP growth estimate for 2016 is 2.7%, with inflation at 3.2%, although we think risks to both are skewed to the downside given the fiscal constraints.
The bottom line: We think these policies will help anchor Mexico’s moderate debt burden and underpin the case for exposure to its credit and rates markets. We find value in both the long end of the domestic interest rate curve and the peso, which we think is about 15% undervalued based on its fundamentals.