USD/MXN Outlook: Should Banxico Keep Rates Steady Or React To Inflation?

Coins, Banknotes, Money, Currency, Finance, Cash

USD/MXN FORECAST: NEUTRAL

We saw the Bank of Mexico (Banxico) hold interest rates steady at 4% on Thursday which was in line with expectations. Economic recovery in the Mexican economy is struggling to materialize given the uncontrollable spread of the virus in Latin America, but Banxico decided unanimously that borrowing costs should not be lowered further after the reading for the first part of March saw inflation shoot up above 4%. Data published on Thursday also showed that economic activity fell 5.4% year-on-year in January, double the 2.7% decline recorded the previous month.

As the central bank outlined in its statement, monetary policy is in a highly delicate situation trying to balance, economic activity, high inflation, and volatile financial markets. So the question now is whether Banxico will continue easing rate to achieve full employment and aid economic recovery, or will it focus on soaring inflation and try and attract capital flows via carry trades?

By keeping rates unchanged from last month's expected cut, the bank is somewhat joining the more aggressive approach of other major emerging economies so far in 2021. Brazil, Russia, and Turkey all raised borrowing costs last week. But keeping monetary policy unchanged for an extended period could also put further pressure on Latin America’s most traded currency. The Peso lost more than 9%until the start of March as rising US Treasury yields and emerging market volatility prompted an exodus of foreign investors from the country's local bonds.

Money markets are now starting to price in two possible rate hikes in 2021 after Thursday’s meeting.

baxico rate probability

Source: Refinitiv

USD/MXN LEVELS

The long-term trend in USD/MXN continues to be bearish at this point, although the past month has provided some choppy trading conditions. I was talking last week about this possible head and shoulders pattern on the daily chart, and although the pair did jump higher at the open this past week, there is still a way to go before we can confirm the pattern is underway.

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