Mexican market to benefit from expected interest rates cut

Mexico's Interest Rates 2013-03-05Enlarge GraphThe spread between the TIIE 28 day rate 1 and the target overnight rate compressed over the past month, signaling a possible rates cut coming up

The TIIE rate is the interbank lending rate in Mexico. Similar to LIBOR2, its comes in several terms, with the 28 day term being the most commonly used benchmark for loans and other financial instruments. The Mexican Central Bank can influence the TIIE yield curve by adjusting its target overnight rate in a similar way the U.S. Fed modifies the Fed rate.

The spread between the TIIE  28 day rate and the target rate varies according to expectations of interest rate changes. Over the past few years the spread has remained pinned between 30 and 40bps and the target rate has being maintained at 4.5%. Over the past month, the spread has dropped approximately 5bps; while the drop may seem minimal, it represents half of the usual spread. The steep downtrend during February shows that investors have started to price in a drop in interest rates.

HSBC analysts expect a 50bps drop to be announced at the next monetary policy meeting in April. While the spread has contracted before in anticipation of a monetary policy meeting in which the rating has remained unchanged, this time around the drop is more likely given the apparent slowdown in the Mexican economy as indicated by recent macroeconomic economic indicators.

A drop in interest rates would cascade a lower cost of borrowing through the economy, promoting growth and boosting the stock market. Additionally, a drop in interest rates would boost bond prices since it would increase the yields on existing bonds.

Investors in Mexican equities, such as those in the EWW or NAFTRAC ETFs, as well as the MXF closed end fund, would benefit from such cut in the short term as investors adjust their increased growth expectations. Other Latam ETFs, such as GML and ILF, have exposures to Mexico at around approximately 25% and would benefit from a rates cut in Mexico.

  1. Mexican borrowing rate  similar to LIBOR
  2. LIBOR: London Interbank Offered Rate