Morning Commentary: Selective Importance

Foreign Exchange - Morning Commentary
Selective Importance
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
Banxico, Mexico’s central bank, will announce its latest rate decision at 11 am PST today.  It is widely expected that the bank will lower its rate by 25 bps to 7.0%.  One of the strongest arguments for rate cuts is the excess capacity in the economy.  With a lack of demand side inflation and real rates high, it would seem that further rate cuts to boost productivity would be the easy answer.  Why then does the central bank appear to be hesitant to ease?

Likely the reason is that Banxico’s policy stance doesn’t represent economic fundamentals but rather concerns over policy driven inflation and growth concerns unrelated to the cost of capital.  Policy driven inflation is easy enough to explain.  Mexico raised it minimum wage multiple times with the increased wage floor expected to push inflation higher. 

The second argument is proved by business sentiment and spending data that shows marked drops.  This decline coincides with an uptick in an economic uncertainty index that the central bank has referenced in the past.  Looking at recent events, this should be a surprise.  Since 2018, Mexico has gone through a general election as well as the cancellation of Mexico City’s airport and previously signed contracts in the energy sector.  Certainly other factors besides policy are at play—oil production related issues have been a drag—but these non-policy factors only account for a fraction of the overall drag.  As such, it is likely that the board views the lack of growth to be predominantly driven by policy uncertainty rather than higher real rates.    

With Mexico’s issues more structural than cyclical, there is only so much support that rate cuts can provide.  Moreover, the central bank might actually desire a higher yield level as it provides a buffer to shocks.  This may seem counter intuitive but think of it this way:  a lower policy rate, amid an adverse shock, could lead not only to a slowdown in capital inflow but a possible reversal which will lead to a negative feedback loop.  Relatively high interest rates will continue to attract fund inflows even during uncertain periods, such as the present as well as in the future with US election campaigning upcoming.
  • The number of confirmed SARS-CoV-2 virus cases jumped by ~15,000 to more than 60,000 cases total overnight.  However, this was mainly due to a change in the methodology for detecting the virus.  Here are a few notes.  1) The new use of CT scans (in lieu of RNA tests) is faster and more likely to pick up cases which brings forward cases that would have taken more days to appear.  2) Lowering the bar for diagnosis raises the number of cases but should lower the overall mortality rate. 
  • The BoC Gov. Poloz spoke last night.  He spoke on the importance of fiscal policy and sounded cautionary on the need for more rate cuts. 
  • In the UK, PM Johnson reshuffled his cabinet, removing Northern Ireland Secretary Julian Smith, Business Secretary Andrea Leadsom, Housing Minister Esther McVey and Attorney General Geoffrey Cox.  Additionally, Chancellor Sajid Javid, who was under pressure to remove all his advisers, resigned.  The GBP is up on the session as markets view Javid’s resignation as potentially opening up fiscal spending that he was previously blocking.    
  • Christopher Waller and Judy Shelton, President Trump’s two nominees to the Fed board, will face lawmakers today.  Waller’s approval is expected to be a smooth one with Shelton’s more uncertain.  The approval of both would signal a dovish shift in the board’s stance. 
  • US CPI missed consensus, coming in at 0.1% versus expectations for a 0.2% rise.  While the number was a miss, the details of the report were fairly positive.  Additionally, initial jobless claims continue to fall with this week’s 205k claims beating expectations for 210k claims.
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