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Mexican Central Bank Issues Surprise Rate Hike

The Mexican Peso is One of the Most Liquid Emerging Market Currencies

The Mexican central bank (Banxico) surprised markets by holding an emergency monetary policy meeting on Wednesday, February 17, 2016, which resulted in the key benchmark interest rate being raised by 50 basis points, from 3.25 percent to 3.75 percent.1 Banxico had hiked rates by a quarter percentage point as recently as December 2015, 2 following the lead of the U.S. Federal Reserve, but after holding rates steady in January 2016, and again in early February, a committee of Mexican central bankers voted unanimously to raise interest rates to stop the decline of the peso that was trading close to record-low levels. The Mexican central bank has been on high alert since the currency fell through a psychological barrier of 20 pesos per U.S. dollar exchange rate. The Mexican peso remains a free-floating currency, although the central bank can intervene with direct dollar sales to help prop up the currency. The higher interest rate will make the peso attractive to yield-seeking investors as corresponding interest rates in developed markets are still close to zero or negative rates in some cases.

The monetary policy decision in Mexico was also delivered alongside budget cuts from the Ministry of Finance. A Banxico statement also cited inflationary concerns as a reason for the interest rate hike.

Mexican Peso a Proxy for Emerging Market Currencies

According to the Bank of International Settlements latest published triennial survey in 2013, the Mexican peso is the eighth most traded currency in the world.3 The rise of the peso came as the developed world was coping with recession after the credit crisis of 2008, which marked the rise of emerging markets. The strong pace of growth in emerging markets was the result of their economies having been tempered by their own regional crisis a decade earlier, giving them an edge and fortifying their financial system. The peso has become a proxy for trading emerging market currencies given the increase in liquidity worldwide with only about a quarter of the daily trading done locally.4 This proxy effect also helps to explain the reasoning that while the fundamentals of the Mexican economy are strong, the currency has fallen more when compared to other nations such as Brazil and South Africa that are currently experiencing economic difficulties.

Oil Market Stabilizes after OPEC-Russia Agreement

Mexico is the 10th largest net exporter of crude oil in the world.5 As global production has hit record highs and demand softens, the tumble in energy prices has continued into 2016. The Organization of the Petroleum Exporting Countries (OPEC) has reached a tentative agreement with Russia to freeze output at current levels.6 While this was greeted as good news from market onlookers, there are issues that lie within this agreement. January production came in close to record high levels for some producers. While this is better than no agreement, it is only marginally better, as the price of crude would have benefited greatly from a cut in production across the board. To make matters worse, some OPEC members, specifically Iran, support the agreement made, but at the same time have no plans of keeping their production levels unchanged. Mexico's oil industry is dominated by the state-owned petroleum company, Pemex, where a lack of reinvestment of energy profits and falling commodity prices have forced the government to implement 100 billion pesos in budget cuts. The higher interest rates come at an auspicious time. Along with the tentative agreement from OPEC to freeze output at January levels, this should help to stabilize the price of oil after it shed over 30 percent in 2015.7
1 Reuters, Mexico unleashes surprise rate hike to smoke out peso speculators, February 2016.
2 MarketWatch, Bank of Mexico raises interest rates, December 17, 2015.
3 Bank of International Settlements Triennial Central Bank Survey, September 2013.
4 Bank of International Settlements Triennial Central Bank Survey, September 2013.
5 International Energy Agency (IEA), 2015 Key World Energy Statistics.
6 Financial Times, Saudi Arabia and Russia ministers agree oil production freeze.
7 Bloomberg data, West Texas Intermediate total annualized performance in USD terms, accessed on February 22, 2016.

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