Mexico: Drop in bond yields justified by falling growth and inflation

Last month, we wrote short-term bond yields in Mexico were biased lower. This has played out amid more signs that both growth and inflation are heading lower. We are waiting for the currency to weaken and/or the cyclical outlook to improve before adding equity exposure.

The growth outlook in Mexico remains weak. Our growth LEI is hovering around zero while underlying indicators – such as real M1 growth – edge lower (see Chart Collection).

A slowing US economy is also weighing on activity. Industrial production is already contracting while our US growth LEI has stalled. The effects of trade tensions also appear to be lingering more than in 2018. Back then, trade uncertainty weighed on Mexican manufacturing intentions, but capacity utilization was trending higher. Today, both investment intentions and capacity utilization have fallen, echoing past slowdowns.

One bright side is that underlying inflation pressures are easing. For example, inflation breadth has rolled over after inflecting higher earlier this year.

This should give the central bank some scope to cut rates. The gap between the policy rate and inflation remains the widest it has been post-GFC.