In recent weeks, uncertainty regarding the future path of monetary policy has increased. In the US, a stronger-than-expected labour market, persistent inflation, and hawkish comments from FOMC members have pushed back the market's expectations for Federal Reserve rate cuts.
In Mexico, headline inflation for March came in lower than expected, remaining unchanged on an annual basis at 4.4%, while core inflation moderated from 4.64% to 4.55% YoY. However, minutes from Banxico's latest meeting, where they eased by 25bp, revealed that most members favoured fine-tuning monetary policy rather than embarking on a continuous easing cycle. We anticipate that the most likely move will be a pause in May, but Banxico should also take into account the favourable inflation data we expect in the coming months (due to seasonality) and the economic activity data, indicating a potential underperformance in 1Q24. The TIIE curve is pricing a pause for the next two Banco de México meetings.
Since Banxico has been signalling a gradual easing cycle, the whole TIIE curve has shifted upwards in the last weeks and the market is currently pricing a year-end rate of 10.50%. All-in-all, we stand pat on our positive view of local rates. We still expect a directional steepening. From a tactical perspective, we still see a more pronounced adjustment at the short end of the MBono curve (2Y-3Y). However, given current volatility, it could take more time to materialise. Nonetheless, we continue to see value in adding duration as a directional position.
Carry cost is still expensive all along the nominal curve, albeit specially in the short and belly tenors (until the 5Y section). Since uncertainty prevails regarding the continuation of the cycle, rates will remain high, thus the scenario will be challenging in terms of carry.
The TIIE curve continues to price a more dovish scenario compared to Mbonos, therefore, swap spreads remain at negative levels but we continue to expect an upward movement in the 5Y-7Y section. In our view, as MBonos should outperform TIIEs, therefore, we remain constructive on nominal rates and maintain our positive stance on MBonos over TIIEs.
The slopes remain at minimums, taking into account their performance over the last 10 years. As mentioned above, a steepening should materialise in the belly and long end. Regarding strategy costs, the neutral carry cost of a steepening strategy in the 2Y/10Y TIIE slope over the next six months has reduced to 76bp since over the last 3M the TIIE curve has shifted downwards.
Lastly, TIIE FRAs remain below spot rates because markets are anticipating a less restrictive monetary stance. Relative value strategies are thus possible in the 2Y-5Y section, as we have pointed out in our previous reports. Spreads are currently negative, so there is still scope to take advantage of the current distortion. We sent a trade idea last week where we mentioned that paying the 3Y/2Y forward rate and receiving the 5Y spot rate looks appealing as the spread is below percentile 15 (sample since 2013). In our view, the spread should adjust to the upside about 50bp as markets move to price in a less hawkish stance. We expect Banxico to cut another 125bp this year.