Latin America’s economies have been hard hit by the pandemic, and Mexico is no exception (Figure 1). As of Q1 2021, Mexico’s economy remained about 4% smaller than it was before the pandemic, with a sharp rebound in Q4 2020 followed by much slower growth in the first quarter of this year. While certain aspects of Mexico’s economy, such as its industrial sector, have done well, services such as tourism have been severely disrupted.
Mexico’s economy was in a recession even before the pandemic struck. Between late 2015 and late 2018, Bank of Mexico, the central bank, raised rates from 3% to 8.25%, which probably contributed to a sharp slowdown in Mexico’s pace of growth. Unemployment remains at around 4.5%, about 1% higher than it was before the pandemic and about 1.25% higher than it was at its 2018 low (Figure 2).
Bank of Mexico began cutting rates before the pandemic, lowering them to 4%. Inflation seems to have given the central bank cause for not lowering them any further. Mexico’s core inflation has now crept above the central bank’s overnight rate for the first time since early 2015 (Figure 3).
South of its border, Brazil’s central bank has found itself in an analogous situation. It too saw core inflation rise above its policy rate. Negative real interest rates have been common in Europe and the U.S. since the global financial crisis of 2008 but are still unusual in emerging market economies where inflation rates have not fallen as low. Faced with negative real rates, Banco Central do Brasil joined Russia’s central bank as one of the first major central banks to tighten interest rate policy since the pandemic began (Figure 4).
Interest rate traders price some risk of Bank of Mexico going in the same direction as Banco Central do Brasil. An implied forward curve of short-term interest rates (STIRS) calculated from Mexican 28-day, 91-day, 180-day and 360-day T-Bills suggests a 50-50 likelihood that Bank of Mexico will begin tightening policy in the next three months. However, Mexico’s interest rate markets imply that traders assume the central bank will have hiked rates by as much as 50 basis points (bps) above current levels between August and October 2021. Furthermore, those same interest rate markets imply a likelihood that interest rates will average about 100 bps higher than current levels between November 2021 and April 2022 (Figure 5).
There are both upside and downside risks to Mexico’s interest rate curve.
All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only. The views in this report reflect solely those of the author(s) and not necessarily those of CME Group or its affiliated institutions. This report and the information herein should not be considered investment advice or the results of actual market experience.
Erik Norland is Executive Director and Senior Economist of CME Group. He is responsible for generating economic analysis on global financial markets by identifying emerging trends, evaluating economic factors and forecasting their impact on CME Group and the company’s business strategy, and upon those who trade in its various markets. He is also one of CME Group’s spokespeople on global economic, financial and geopolitical conditions.
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We will introduce interest rate futures based on the Central Bank of Mexico's Overnight TIIE funding rate (F-TIIE) on May 24, 2021, pending regulatory review.