The TIIE curve was largely unchanged last week, with the exception of the 3M tenor, which widened c.20bp. The TIIE curve is still signalling that Banco de México will continue to hike in the months to come in tandem with the FOMC, and that inflation will remain under pressure. Indeed, the markets are pricing in a terminal rate of close to 10.25% in the next six to nine months and a gradual easing cycle beginning around a year out. As we have mentioned in our previous reports, we believe that Banxico will most likely follow in the footsteps of the FOMC, and thus maintain our view that the central bank will end the tightening cycle in 2022 with a terminal rate of around 9.75%. Due to these monetary policy expectations being baked into the TIIE curve, its shape has remained inverted up to the 5Y tenor and relatively flat further up the curve. In our view, given the prevailing uncertainty regarding the future path of monetary policy, nominal curves will remain inverted in the near term. However, as we believe that the end of the tightening cycle is at hand, nominal curves could see some shape shifting in the medium term.
In terms of TIIE carry roll-down, and over a six-month horizon, the drip continues to be positive at the very short end of the TIIE curve, especially in the 9M and 1Y tenors (nearly 50bp on average) as markets are factoring in a more aggressive approach from the central bank. As previously stated, Banxico will most likely continue to tighten monetary conditions, and thus the drip in the very short end is pricing in this action. However, the drip remains negative in the rest of the curve because of its inverted/flat shape. Meanwhile, swap spreads remain at lows, as TIIEs outperformed MBonos except in the 9M and 1Y tenors, where a more aggressive approach from Banxico is being priced in. Indeed, the 1Y TIIE swap spread based on figures since 2010 is now in the 75th percentile compared to the 10th percentile average for all other areas of the curve.
Spreads are at minimums all along the curve based on historical figures since 2010. While the flattening has been quick and aggressive, the slopes have been volatile. The reasons for an inverted curve remain, so we would expect flatter slopes and an inverted curve in the short term. The flattening has been so aggressive that markets moved to price in a steepening of the curve. Indeed, for the next six months, the neutral carry cost of a steepening strategy is close to 20bp, which means that the market continues to expect some curve steepening. As we have mentioned in our previous TIIE Radars, the case for a directional steepening strategy in the 2Y/10Y has begun to make sense. Even though the curve will most likely remain distorted at the short end, the current low cycle cost favours a hold in long-term steepeners. Indeed, when we first recommended the strategy, the carry cost was close to zero, in stark contrast to the 20bp that the curve is pricing in with the latest data (see our note “MX - The room is open to take steepening positions at the 2Y/10Y TIIE slope,” released on 28 July 2022).
Finally, FRAs remain above spot levels at the very short end of the curve. From the 1Y tenor onwards, FRAs are now below spot levels, due mainly to the fact that markets have moved to start discounting lower benchmark rates. However, FRA spreads vs. spot rates have recently increased, and levels are tighter than three months ago. Receiving forward rates and paying spot rates continues to make sense to us in the very short end of the curve (from the 6M to the 9M sector), but room is now more limited. In contrast, spread levels for the longer terms (2Y-10Y) remain in negative territory, as the spot rate has moved more aggressively than the forwards are pricing in. Indeed, in the 1Y/1Y vs. 2Y TIIE and the 3Y/2Y vs. 5Y TIIE, the spreads are at minimums, which enables paying the forward rate and receiving the spot rate.