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Mexico cuts interest rates 50bps, market receives boost

Mexico's Interest Rates 2013-03-11Enlarge GraphThe Mexican Central Bank (Banxico) announced on Friday evening that it will cut the target interest rate by 50bps, which will benefit market growth.

Many countries operate a monetary policy that aims to boost economic growth by lowering interest rates and halting inflation by raising them. The intent is to achieve sustainable economic growth with low inflation.

The market was expecting a rates cut in Mexico given the slow down in the industrial sector output as well as weakened manufacturing expectations. Additionally, unemployment remained elevated above 5%, which represents a historical elevated level for Mexico, and both consumer and producer price inflation were showing decreasing trends, providing a constructive environment to lower rates without inflationary pressures.

The 28-day TIEE rate, which is a lending benchmark rate for floating rate loans (similar to 30-day LIBOR in the U.S.) had decreased over the past month from 4.83% to 4.75%, signaling that the market was starting to price in a rates decrease. The spread between Banxico’s target rate and the 28 day TIEE has been approximately 35bps over the past five years. Whenever the spread expands or contracts, it is a sign that the market is expecting a rates cut or hike, respectively. Over the past month, the spread had expanded to 43bps, clearly showing a cut was expected.

Investors in Mexican ETFs (e.g. EWW, NAFTRAC) and closed end funds (e.g. MXF) should learn to recognize these patterns to anticipate monetary policy actions by central banks. EWW, for example, climbed $1 in the few days leading up to the announcement, which represented a 1.3% gain. Given the sluggish production numbers and no potential blockades due to inflation, it was a textbook play that rates would be cut. Mexico is just one of many countries that employ inflation-targeting monetary policies. Brazil (EWZ), for example, recently left rates unchanged, which was also expected since the inflation pressures threatening a rates hike had decreased over the past month. The Bovespa index in Brazil also gained a little over 1% in the days leading to the monetary policy meeting.

Investors interested in emerging markets (e.g. VWO, EEM) can follow the monetary policy of their countries of exposure to tailor when to cut or add to existing country holdings to protect and/or boost gains.

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