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Banxico Expected to Keep Rates at 4%, but a Hawkish Pivot May Support the Mexican Peso

BANXICO KEY POINTS:

  • Banxico will announce its fourth monetary policy decision of the year on Thursday
  • No change in interest rates is expected, but the central bank could adopt a more hawkish language in response to the deteriorating inflation outlook.
  • A hawkish pivot in forward-guidance could support the Mexican peso over the medium term. However, in the near future, US treasury yields dynamics and broad market sentiment could be more relevant to USD/MXN price action.

Most read: USD/MXN charges higher, what’s driving price action volatility?

The Bank of Mexico (Banxico) will announce its June monetary policy decision on Thursday. The institution led by Alejandro Diaz de Leon is expected to stand pat and leave the overnight rate unchanged at 4.0%, thus keeping it steady at that level for the third consecutive meeting.

In view of the increase in consumer prices caused by supply and demand factors, Banxico could adopt a more cautious tone and reiterate that the inflation path remains skewed to the upside. As a side note, in its latest quarterly report, the central bank revised higher its CPI projection for 2021, raising its forecast to 4.8% from 3.6%, significantly above the upper limit of its target range at 4%.

With mounting inflation risks, including a rise in short-term expectations, and a more balanced outlook for economic growth aided by strong external demand and accelerating COVID-19 vaccination rates, it would not surprise if Banxico began to pave the way for some policy normalization, following in the footsteps of other emerging market central banks, such as Brazil’s COPOM.

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An outright hawkish tilt in its forward-guidance or a divided decision could be seen as positive catalyst for the Mexican peso mid-term. Over the longer horizon, however, any signals or message conveyed by the board now are likely to be irrelevant as the bank will have a new governor in 2022. Early this month, President Andres Manuel Lopez Obrador ruled out a second term for Diaz de Leon when he finishes his tenure in December and nominated current Finance Minister Arturo Herrera to lead the institution. With Herrera at the helm of monetary policy, Banxico could take-on a dovish lean, although it is too soon to draw firm conclusions.

In any case, in the very short term, the Mexican peso will be more sensitive to external factors such as the dynamics of US Treasury yields and the tone of the market in response to the Fed’s tightening bias. That said, if risk aversion spikes again like last week and panic-selling sets in, EMFX could suffer heavy losses, pushing the USD/MXN exchange rate towards the 21.00 or even above that. Typically, when risk-off sentiment takes hold, traders turn to the safety of the US dollar, unwinding riskier positions, an scenario that undoubtedly exacerbates volatility.

USD/MXN TECHNICAL ANALYSIS

USD/MXN broke a key technical resistance near 20.30 last week as risk aversion boosted the greenback and safe-haven assets in general. After piercing through that barrier, the price briefly rose to 20.75 on Friday, but the buying momentum faded earlier this week, leading to a small pullback.

For USD/MXN to resume its medium term downtrend started last year, we would need to see a clear move below 20.30 on a daily closing basis (this level was previously resistance, but it is now support). If this scenario materializes, the price could head back towards its 2021 lows near the 19.60 area. On the other hand, if buyers regain control of the market and the dollar strengthens, the first resistance comes at the 21.00 psychological mark, followed by 21.63 (2021 high).

USD/MXN TECHNICAL CHART

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—Written by Diego Colman, DailyFX Market Strategist

Follow me on Twitter: @DColmanFX


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