Mexico: Central bank to cut today

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This analysis comes via Brown Brothers Harriman (I have bolded a few lines):

Mexico’s central bank is widely expected to cut its overnight rate by 25 bp today. That would bring it to 7.25%. Last month it delivered a 25 bp rate cut too. The market had expected a 50 bp cut and punished the peso in disappointment. However, the peso has strengthened sharply in recent days-up until yesterday–and this has renewed some speculation of a 50 bp move today. This seems unlikely. Consumer inflation remains stubborn. It was 6.2% in Feb, having peaked at 6.53% at the end of last year.

Mexico’s economy is contracting. Domestic demand is weak and of course foreign demand (primarily the US) is poor. The main sources of capital inflows into Mexico–exports, worker remittances and tourism are drying up. Oil prices are roughly a third of where they were 9 months ago.

Mexico has spent some $20 bln to slow the peso’s descent or roughly 5% of its reserves. Central Banker Ortiz is unlikely to risk the new found stability in the currency may cutting rates more aggressively. Given the pass through of a weaker peso on imported inflation and then domestic inflation, means that policy makers think that the stability of the peso is the key to capping inflation.

Mark Twain once said that history doesn’t repeat itself but that sometimes it rhymes. In this context, it would suggest that the peso may not sell-off on a 25 bp rate cut like last month. On the other hand, K Marx said that history repeats itself–the first time as tragedy the second time as farce. That would suggest that the peso might in fact sell-off again. Technicals are more aligned with the latter scenario. Hourly technical indicators suggest the overnight recovery in the peso has left it over-extended. Look for the dollar to bounce back from a test on MXN14.10.

Clearly there is downside risk here.  Remittances are down.  Oil revenue is down. Tourism is down.

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Apropos tourism, the Mexican travel industry is extremely worried about the bad press the country has been receiving in the U.S. about the drug trade and murders of late.  I am going on holiday in Mexico next month and my resort sent me the following e-mail two days ago:

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Dear Customer,

While millions of U.S. and Canadian citizens safely visit Mexico each year, including thousands who cross the land border every day for study, tourism or business, the display of travel warnings as well as details of unexpected events has increased recently.

That being so, we would like to clarify as well as to reassure that our company has strict security measures such as 24 hour security surveillance and guards. Additionally, access to the hotel is strictly controlled and limited to guests only. We must stress that our priority is to ensure that all of our members will be provided with the highest safety and security while visiting our Resorts.

Please be advised that the majority of the news of violence refer to the drug war, an unfortunate situation occurring mostly in the northern border states of Mexico, and does not significantly affect any tourist destinations.

Furthermore, our concierge and hotel manager will be more than happy to answer any questions you may have prior or during your arrival. Please keep in mind that we are working hard to ensure that you and your family have a safe and pleasant vacation.

If you need further assistance, please do not hesitate to call us at any of the numbers listed below.

I have never been worried about safety at this resort – it is a lovely place. But, this message actually had the perverse effet of making me think twice.

Update 1120ET: The Mexicans went super-aggressive and cut 75 beeps. Obviously, they do not want a repeat of last go round. Perhaps they are taking cues from Ben Bernanke on how to get this downturn sorted? Anyway, BBH has this to say after the fact:

The Mexican central bank surprised the market by delivering a larger than expected rate cut. The 75 bp cut brings the overnight rate to 6.75%. Last month the central bank disappointed expectations and the peso fell. This time it surpassed expectations and the peso rallied. The central bank justified the rate cut on grounds that inflation expectations have been anchored and the downside risks to the economy are growing. The official concern is more about the growth trajectory than price pressures, which it thinks has been easing in recent months. The dollar fell to about MXN14.00 on the news from near MXN14.20. The greenback has recovered quickly back to MXN14.10. With the finance ministry making it clear that it is not oppposed to the peso being weaker than MXN14.00 and news the Cemex has postponed their earnings until late next month should see the peso weaken as the impact of the unexpectedly large rate cut wears off quickly.

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