- In this note, we develop a simple economic framework to assess Mexico’s business model. As we delve into the trade DNA framework, we describe how Mexico faces economic shocks as a small open economy. The aim is to better gauge the understanding of Mexico’s economic cycle, how it faces economic shocks as a small open economy and its role in financial markets.
- The majority of both imports and exports are concentrated in high-value-added goods. This has been pivotal in shaping the Mexican economic cycle and the significance of the manufacturing sector.
- The economic openness has rendered Mexico more vulnerable to external shocks, unlike other Latin American economies. Mexico’s emphasis on high-value-added trade where the country imports high-value-added intermediate goods and re-exports final consumption goods, leaves it particularly vulnerable to disruptions in supply chains. In contrast, other Latin American countries are more susceptible to volatility due to shocks in non-oil commodities prices. Additionally, Mexico's primary trading partner is the US, accounting for 61% of total trade in 2023, making the Mexican economy highly sensitive to the US economic cycle.
- From a financial markets perspective, Mexico is also a small open economy. The value of Mexican assets largely reflects fluctuations in global risk appetite or aversion, while local catalysts lack the capacity to influence global markets.
- Based on the economic and financial market’s openness, local assets’ response to domestic variables depends on the global context. This is, local assets (particularly the Mexican peso) tend to overreact to global risks, not only those related to the US economy but also to geopolitical factors. Derived from the high liquidity of the peso, volatility becomes more relevant when seeking to benefit from the carry trade.
- Given the significant relevance of the carry trade on the value of the MXN, monetary policy has had to be prudent to avoid second-order effects on inflation. Currently, we consider that Banxico has room for policy easing in the upcoming meetings. The delay in the start of the easing cycle by the Fed and the cautious stance of the Board have increased the probability of a pause in the May meeting. Nevertheless, our optimistic stance on local rates remains unchanged. Anticipating a gradual easing cycle, we continue to see value in extending duration as a directional position.
- Finally, the MXN remains anchored by its carry and boosted by global risk appetite on growth expectations. However, we have been negative towards the currency due to a stretch valuation, deterioration in macro fundamentals, expectations for political noise and a higher risk premium and due to our view for a lower interest rate differential ahead. Thus, we remain cautious and keep expecting a depreciation towards USDMXN at 17.40 in the coming two months and 18.20-year end.