During last week, the TIIE curve rallied nearly 7bp on average, but markets continue to expect more benchmark rate hikes in the coming months. The TIIE curve is pricing in between 130bp and 217bp of hikes in the next six months to one year, and a terminal benchmark rate close to 8.30% in 2024. As we mentioned in our note “MX – Nominal curve slopes can fall further,” released on February 18, 2022, Banco de México will most likely keep a hawkish tone in coming meetings. The odds are that the FOMC will start tightening as soon as next month, an action that would most likely be mirrored in Mexico. Inflation will hardly fall in the near term, and the Board remains more focused on containing inflation. We do expect the central bank to slow the hiking pace to 25bp and see the benchmark rate at 7% in 2022. Still, in the near term, markets will most likely keep pricing in a more aggressive tightening cycle as uncertainty regarding the decision-making process prevails.
In terms of carry roll-down, considering a 6-month horizon, drip continues to be attractive at the short end of the TIIE curve, especially in the 9M and 1Y tenors (nearly 120bp on average) as markets are factoring in a more aggressive approach from the central bank. Meanwhile, swap spreads maintain their upward trend starting in the 9X1 tenor, and in the very front (3x1 and 6x1) the MBono is pricing in a more hawkish stance than the swap curve. Because of this, swap spreads remain at minimums at the short section. In our previous radars, we stated that swap spreads increase when Banxico starts tightening conditions, and we see scope for an additional upside in the short term.
The TIIE curve has flattened between the short end and the belly, and it is now inverted in that section. Indeed, spreads are at minimums considering history since 2010. While the flattening has been too fast and aggressive, in our view, the reasons for an inverted curve remain, so we would expect to see the slope decrease further in the short term. At the very short tenors, however, spreads remain distorted; indeed, the 1Y/2Y slope spread is close to its 70th percentile as markets have moved to price in more hikes from Banxico. The curve distortions would probably prevail in the near term. Nevertheless, once CB’s approach becomes clearer, spreads between the belly and the short end could probably increase while those in the very short end (1Y/2Y, 1Y/3Y) should fall.
The drip cost of a flattening strategy is around 40bp between the short end (2Y) and the belly (10Y). In terms of forwards, the 2Y/10Y slope is pricing in an additional flattening of 15bp. We reiterate that, as a directional trade, we continue to anticipate lower slopes because activity risks will prevail, and Banxico is already immersed in a tightening cycle.
Regarding butterflies, spreads at the short end (1Y-7Y) are at maximum levels, close to their percentile 90th on average. Flattening strategies are expensive in that section of the TIIE curve because of recent carry roll-down levels. Meanwhile, butterflies between the short end, the belly, and the long end are still negative, and their levels are actually at their lowest percentile.
Finally, FRAs remain above spot levels in their entire curve. Spreads at the short end (from the 3M to the 1Y) continue to increase because forwards have moved more than spot rates. Therefore, receiving forward rates and paying spot rates continues to make sense in that section. In the 5Y (3Y/2Y), levels have been decreasing, and the spread is now in negative territory as the spot rate has moved more aggressively than what the forwards are pricing in. Meanwhile, in the 10Y (5Y/5Y vs. 10Y), the spread seems tight because it has recently decreased and is close to zero, which limits the scope to start a strategy.