Consistent Carstens’ high standing among investors has helped Mexico withstand FX volatility
It is fitting that Agustín Carstens has won Emerging Markets’ Latin American central banker accolade every odd year during his tenure as governor of Banco de México (Banxico), for his consistency is the quality that investors and analysts most often emphasise.
“I’d highlight the very consistent message you see from Carstens,” says Alvaro Vivanco, Latin American strategist at BBVA. “Shifts in policy are gradually introduced into the minutes beforehand and you have to give him credit for creating a consensus internally.”
This consensus has, in Vivanco’s view, “anchored inflation expectations and really anchored the bond curve, which — impressively — trades separately from the currency”.
Mexico’s highly liquid currency has, predictably, not escaped the sell-off in EM FX this year. The peso has lost around a quarter of its value versus the US dollar in the past 12 months.
But it is not just in the local bond markets that the pass-through from the currency sell-off has not been as high as might be expected: inflation is seemingly under control in the face of the weaker peso. Having been above target for much of 2014, in August annual inflation fell to 2.59% — the lowest level since the 1960s.
“Inflation, both core and headline, is at a record low, which is a big achievement for Mexico,” says one EM macro fund manager. “In the past, a weakening exchange rate would have meant rising inflation but not these days.”
The fund manager compares Mexico’s situation to that of its regional peers Chile, Colombia and Brazil, where central banks face the opposing pressures of high inflation but low growth.
“Banxico’s decision to cut rates by 50bp in June 2014 appears prescient today, while the decision to build up FX reserves aggressively over the past five years in order to use them now also appears responsible,” says the investor.
Inflation is what Vivanco believes makes Carstens stand out versus his peers in the region. Low inflation has allowed Banxico to sit tight where other Latin American central banks have had to hike despite cuts in growth forecasts across EM.
Yet Carstens has hardly been dovish and most expect the eventual US rate rise to trigger a similar move in Mexico. In a sign of the importance of US rates to Banxico, the central bank this year took the unusual decision of deciding to move the dates of its meetings to follow US Federal Open Market Committee (FOMC) meetings. This ability to make the markets understand that Banxico will not be afraid to react has been crucial for the stability of the markets.
“A lot of people ask why Banxico has pushed such a hawkish message, but I think it is proving to be a good strategy: offshore investors are not leaving Mbonos,” says Vivanco of BBVA.
Previously Mexico’s finance minister as well as deputy MD at the IMF, Carstens — perhaps more so than any other policymaker in Latin America — has a voice investors will always listen to.
“He is not afraid to touch a controversial subject and ask the finance ministry to strengthen Mexico’s ‘macroeconomic framework’,” says another EM bond investor. “In other words he’s calling for fiscal austerity and dropping hints to the government — but for the right reasons.”—Oliver West
CONFIDENCE IN FUNDAMENTALS HELPS NAVIGATE TURBULENCE
“Despite volatility in financial and commodity markets, people have confidence in our monetary policy,” Agustín Carstens, whom Mexico’s government nominated to lead the central bank for a second six year term in September, tells Emerging Markets. "Our main challenges concern volatility rather than fundamentals."
“Navigating in a smooth fashion is key and requires both strong monetary policy and a reinforcing of fiscal policy.”
In the case of Mexico, the close link to the US economy means that a potential rate rise is the most imminent cause of volatility. So far, low inflation has given Carstens the luxury of not having to raise rates in a modest growth environment, but Bank of America said in September that it believed market consensus was that Banxico was on “autopilot” waiting for the Fed to act.
Carstens says the word “autopilot” is an exaggeration, though he admits it is “true that US monetary policy has become a very relevant factor in our decisions — mainly because of the effect on the FX market and, subsequently, inflation”.
Banxico’s board has debated as to whether it should hike before, after or with the Fed, but “the consensus is to be prepared to act if necessary when the Fed moves”, says the governor.
Portfolio adjustments generated by the US rates lift-off will be “manageable”, he says.
“Once markets digest the rates lift-off, people will see it is positive for Mexico,” says Carstens. “A rate hike would indicate a stronger US economy, which should support growth in Mexico.”
Bond investors and strategists praise the fact that the Mbonos local government bond curve has held up well in the face of a sharp devaluation of the peso.
Carstens first points to the “deep and well developed FX and capital markets, with plenty of derivative use possible to hedge risk” as a reason for the relative stability in Mbonos.
But long term fundamentals are again crucial in encouraging investors into Mexico and long term institutional investors “anticipate” a certain level of turbulence as they invest with a 20 or 30 year horizon.
“These investors have long term confidence because the institutions that conduct policy are consistent with their objectives,” says Carstens. “Macroeconomic fundamentals in Mexico are strong and the clear objectives of Banxico and the finance ministry have induced many investors to stick to their positions during this turbulence.”