Rabobank’s RaboResearch team, including Molly Schwartz and Christian Lawrence, expects Banxico to keep its overnight rate at 6.50% on November 5 and through 2027, even as the Federal Reserve is seen hiking. They highlight that a narrowing interest rate differential has already weakened the Mexican Peso, and further divergence from the Fed could pressure USD/MXN higher while inflation remains contained in core components.

Peso sensitivity to rate divergence

"We expect Banxico to hold the overnight policy rate at 6.50% at the November 5 meeting, in line with both market pricing implied expectations and the median expectation of Bloomberg surveyed analysts. At the September 24 meeting, the Bank adjusted its Statement tangibly to give it more flexibility to diverge from the 6.50% rate it had been previously holding."

"Heath also acknowledged some of the challenges that arise should Banxico diverge from the Fed, primarily how it would impact the peso. Indeed, the peso materially weakened in the aftermath of that September meeting, with USD/MXN soaring from sub-17 levels, to almost reaching 19, a move that was compounded by rising 3-month implied volatility. This was a move that was driven primarily by the perception that we will see further narrowing of the interest rate differential."

"In such a scenario, a weaker peso could fuel inflation further in Mexico, but given that inflation in Mexico is moderately contained (in core goods and services), the economy can probably afford to digest a weaker peso. Meanwhile, a stronger peso puts downward external demand for Mexican agricultural exports, which would weigh on an already sluggish economy."

"Despite the prevailing risks to inflation in Mexico, market sentiment is currently skewed in favor of Banxico cuts in the short term, with several Bloomberg surveyed analysts forecasting a cut at this meeting, to bring the policy rate to 6.25%. However, we believe volatile headline CPI inflation and the continued risks to energy leave the Bank reluctant to hike at this juncture, and we maintain our forecast for a hold at 6.50%."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor. Know more.)

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