Mexico’s close relationship with the US could spell trouble for the Latin American country if the US Federal Reserve (Fed) continues to raise its rates. This is partly because Mexico’s central bank (Banxico) has followed in the Fed’s footsteps in previous rate hikes. While the US is not expected to face a recession, a stagflation is a possibility, which could leave Mexico in a similar situation.
The world has entered a period of strong market volatility, and what used to work for investors before COVID-19 is a lot less certain now. The Fed seems resolved to continue raising interest rates to moderate the economy and bring down prices, which will likely bring a major economic slowdown in the long term, said BlackRock during its Future Forum “Investing in an era of volatility.”
In its efforts to address the uncertainty and help Mexico’s economy, Banxico has followed the Fed’s movements. Interest rates have risen as central banks have tightened policy, creating pressures for emerging markets and developing economies. In addition, many countries have limited fiscal room for maneuvering especially following Russia’s invasion of Ukraine, which has contributed to economic fragmentation as many countries severed trade ties with Russia.
“I think inflation is a choice and it is one that the federal reserve has to make … keeping in mind it is easier to control inflation if you have more competitive pressures on workers and some attenuations for those pressures,” said LawrenceSummers, Harvard economist and former US Treasury Secretary, during the forum.
Inflation could come down at a rate of 8-9 percent, but there is also an underlying inflation rate of 5.5 percent once transitory factors are taken out of the equation, says BlackRock. Gargi Chaudhuri, Head of iShares Investment Strategy Americas, BlackRock, added, “some of the inflation is actually supply-driven. Some of the inflation is actually led by the price action we saw on energy prices, food prices and others.”
BlackRock is also optimistic about the dollar’s strength going forward, given the relative quality and strength of the US economy. A similar situation can be seen with the Mexican peso because while the Mexican peso has seen a continuous depreciation for a long time, this has not been the case so far, mainly due to the high-interest rate differential, the relatively low external balance, the increase in remittances and the accelerated level of exports, as mentioned by Lorenza Martinez Trigueros, CEO, Banco Actinver, during Moody’s “Inside LATAM” event.
In both situations, the “ghost” of stagflation is much more likely to take hold than a recession, but much will depend on what happens going forward and how both the Mexican and US monetary institutions react.