The Week Ahead: Mexico – Into A Recession

Foreign Exchange: The Week Ahead
Mexico – Into A Recession
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Alan Rose
Alan Rose
Foreign Exchange Senior Trader
Revised data shows Mexico's economy contracted by 0.1% for three straight quarters before stagnating in Q3 putting the economy into a recession. This is highly unusual in that Mexico has rarely gone into a recession while the U.S. economy has continued to grow. This is even more puzzling because the two economies have become more integrated through trade since NAFTA and Mexico became the number one trading partner of the U.S. in 2019 surpassing Canada, China, and Japan.

The last time that Mexico went into a recession that was not accompanied by a U.S. recession was in 1995 during the so-called Tequila Crisis. The Mexican government, at that time, had embarked on an excessive and expansionary fiscal and monetary policy mix that was politically motivated for the upcoming national elections. Financial markets reacted negatively and ultimately the government was forced to devalue the Mexican peso by nearly 14% in December 1994. This precipitated a sharp and deep recession that caused Q1 GDP in 1995 to post a record low of nearly -6.00%.

Part of the blame for weaker growth this year is related to reduced global trade volumes and weaker demand for Mexican exports. Another part of the equation is the failure of Congress to pass the USMCA agreement which is keeping business investment sidelined on both sides of the border as the uncertainty continues. The Banco de Mexico has responded to the economic weakness and declining inflation by cutting interest rates for the first time in five years in August and followed that up with two more rate cuts bringing the key overnight rate to 7.50%.

A small silver lining to all this negativity is that the Mexican peso (MXN), while remaining volatile throughout the year, is nearly unchanged to the U.S. dollar since January. Most recently, the MXN has been weakening due to contagion affects from other South American countries and expectations of further Banco De Mexico interest rate cuts. In fact, the MXN is the only Latin American currency to have appreciated against the U.S. dollar this year, appreciating by 0.71%; Argentina is down by 37% and Chile is down by over 14%...many of these currencies have hit new all-time lows.

Mexico is our neighbor and partner…we have a vested interest in doing what we can to help them so their economic problems don't deteriorate or morph into something much bigger. Congress should pass the USMCA as soon as possible, remove the uncertainty, and help them jumpstart their economy.

MAJOR CENTRAL BANK ACTIVITY THIS WEEK

12/2 Australia Expectations for rates to be unchanged at 0.75%
12/4 Canada Expectations for rates to be unchanged at 1.75%
12/4 Chile Expectations for rates to be cut by 25 bps to 1.50%
12/4 India Expectations for rates to be cut by 25 bps to 4.90%

KEY MARKET MOVING ECONOMIC RELEASES

United States and Canada

12/2 ISM Manufacturing Expectations for a gain from 48.3 to 49.2
12/5 Trade Balance Expectations for an improvement in the trade deficit
12/6 Jobs Report Expectations for a gain of 190k jobs; UR remains at 3.6%
12/5 Canada Trade Report Expectations for the trade deficit to widen
12/6 Canada Jobs Report Expectations for a flat jobs report; prior month was -1.8k

Europe/Eurozone 

12/4 German Factory Orders Expectations for a gain of 0.5% following a 1.3% gain
12/5 German Industrial Prod. Expectations for a gain of 0.2% after a -0.6% decline

Asia/Japan, and New Zealand 

12/3 Chinese Caixin PMI Expectations for near unchanged at 52.0
12/3 Aussie Q3 GDP Expectations for a gain of 0.5%; YoY rises to 1.6%

FORECASTS

EUR

November has brought a change in trend for both the EUR and GBP after a strong performance in October centered on improving Brexit expectations as both currencies moved higher in tandem. While the GBP consolidates near the upper end of its range, the euro has struggled and weakened but seems to have good support at $.1.0975 for now. Continue to expect the EUR to shadow and be hinged to the GBP and Brexit volatility as the U.K. election approaches. Expect a steady to slightly weaker EUR this week.

GBP

The GBP had a spectacular October resurgence supported by a sharp reduction in the likelihood of a hard Brexit due to PM Boris Johnson's breakthrough Withdrawal Agreement with the EU and his positive political maneuvering with the U.K. Parliament. Polls still favor a small Tory majority but the situation will remain fluid as we approach the December 12 election... Past Tory political campaigning/posturing prior to previous elections since 2015 has been humbling. Continue to expect short term GBP volatility but as long as polling shows Tory support, the GBP will remain steady to higher.

JPY

The JPY has been on a weakening trend ever since U.S. – China trades have resumed dating back to September 1. Risk sentiment has improved and U.S. interest rates have been on the rise as positive sentiment builds toward a Phase 1 agreement. U.S. - Japanese interest rate differentials still have a solid correlation with the JPY exchange rate movement, but there has recently appeared some underlying JPY weakness uncorrelated to interest rate developments. Expect a steady to weaker JPY this week.

CAD

The Canadian dollar has followed a similar path to other major currencies transitioning from October to November where strength has been followed by weakness. Overall, Canadian economic fundamentals remain in good shape relative to its peer group, but a stronger U.S. dollar in November has ensnared the CAD to weaken; however, it has stabilized near 1.3275-1.3300. Both Canada and the U.S. report their respective jobs reports on Friday morning at 5:30 am PST.

CNY

As optimism continues to build for a mini-breakthrough on Phase 1 of the U.S. – China trade talks, the CNY has continued to strengthen since mid-October. Over the past two weeks, the CNY has stabilized between 7.01/$ to 7.05/$ as the market awaits details and a signing date of the Phase 1 agreement. At this point in time, there is market fatigue regarding the trade talks and continued headlines surrounding Hong Kong where price action is extremely muted to the headlines. Expect a steady and range bound CNY this week.

AUD

Outside of the Latin American currency collapse this past month, the Aussie is the weakest of the major currencies. Despite the more upbeat nature of the U.S. - China trade talks, the Aussie has not benefited at all and has fallen most of the month and in seven of the past eight sessions as have many other commodity and energy-linked currencies. The market remains highly concerned about a slowing Chinese economy and weak Chinese and global demand for Aussie exports. While the market expects no change from the RBA this week, there is nearly a 60% probability of an interest rate cut in early February. Expect a volatile week with the market keying off of the RBA forward guidance statement combined with the U.S. jobs report.
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