Economics: FX Conundrum Ahead of Rate Liftoff
Mexico’s exchange rate has consistently depreciated since the end of the third quarter of 2014, and began to accelerate its climb by last February in a move that took the 48-hour FIX exchange rate from 15.24/USD in March to 15.94 in July and an average of 16.24 pesos per dollar so far in the month of August. This signifies a depreciation of close to 15% compared to the closing of 2014, and 25% compared to the Mexican currency’s average for August 2014.
The list of reasons for the depreciation includes expectations that interest rates will soon begin to rise in response, in part, to the continuing strength of US labor variables. Interest-rate liftoff concerns have affected not only the peso’s value against the dollar but also those of other emerging and developed currencies.
In light of the depreciation the Mexican currency experienced in the past two months, and especially after the 48-hour FIX rate reached 16.45 pesos to the dollar on July 30, Banco de México decided to almost quadruple the amount of dollars on auction at a minimum price each day from the USD52 million available since March of this year to USD200 million without a minimum price.
As we noted in the March 16 issue of Weekly Trends: Mexico Economy, when the peso climbed from 10.6 to the dollar in September 2008 to 14.6/USD in February 2009, over a period of months the monetary authority used a variety of mechanisms to inject roughly USD 31.40 billion into the market. Although circumstances differ considerably today, the central bank is armed with approximately 160% more in foreign currency reserves this time around and has managed to auction close to 8 billion dollars at the same time as it has at its disposal a USD 70 billion flexible line of credit with the IMF, factors that leave it with plenty options.
The possibility is that the government will fail to implement promised public spending cuts – it has yet to effect those scheduled to date by the Ministry of Finance – in which case the government would have to expand public debt at a time of rising interest rates and depressed oil prices. That combination could translate into a perception of heightened risk surrounding Mexico’s macro-financial stability and in the process further stoke foreign exchange volatility and pressure the peso even higher.
In this environment of financial uncertainty the authorities released last week industrial activity data for June that proved to be weak, as activity grew a relatively lackluster 1.4% above levels of a year earlier as opposed to the 2.1% expansion recorded for June 2014. The two main factors contributing to the weak headline number were the extent to which the roughly year-and-a-half long contraction in extractive industries continued unabated and the loss of momentum in the construction sector.
Quarterly industrial results more clearly reflect the extent to which the sector has slowed since the second quarter of this year. Between April and June 2015 industrial activity grew by a mere 0.6% compared to a year earlier, as opposed to the 1.1% increase recorded for the same period of 2014 and the 1.5% rise posted for the first quarter of this year. Just as we saw in June, the decline in mining and the recent slowing of construction activity had a negative impact on the quarterly results for the broader sector and even factory activity.
On a related note, last week Mexico’s central bank lowered its 2015 GDP growth forecast for the fourth time this year, paring the growth interval to 1.7-2.5 percent from the previous estimate range of 2-3 percent. As part of its quarterly report on inflation, the monetary authority cited a decline in oil production and industrial activity in general as the main reason for the country’s diminished growth prospects, along with the limited growth seen in internal demand components.
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