Last week, Banco de México kept the reference rate unchanged at 11.25%. The decision was unanimous and the statement again hinted that the reference rate will most likely remain at current levels for a prolonged period. This reference will most likely be alluded to again in coming meetings, but we see prospects of policy easing by year-end. Although the TIIE curve remains inverted, we anticipate a downward movement and a steepening, even though the curve could probably remain inverted in the short term. Because of Banxico's recent decisions, the TIIE curve is no longer pricing in more hikes but rather rate cuts in the next six months.
As we mentioned in our recent Asset Allocation update, the nominal curve usually shifts to the downside following hiking cycles once the CB reaches its terminal rate, and we are expecting this to happen again this time. Given the current inverted shape, the short end should benefit the most, notwithstanding that current levels are already pricing in an easing cycle. In our view, given the ongoing inflation moderation, the curve should steepen because the short end is discounting more aggressive cuts. Because of this disinflation trend, we see room for Banxico to cut the benchmark rate by 4Q23 and thus remain constructive on the short end of nominal curves. In particular, we still see more value in the 13X1 TIIE vs. the 26x1.
Swap spreads remain at lows starting at the 2Y tenor as MBonos are discounting a more dovish approach. At the very short end of the curve (9M-1Y), spreads are positive and starting to normalise. Meanwhile, in terms of TIIE carry roll-down, and over a six-month horizon, the drip is negative all along the curve due to its inverted shape, especially the 1Y-3Y section.
Slopes remain at minimums in all of the TIIE curve based on historical figures since 2010. In our view, the reasons for an inverted curve remain, but normalisation could materialise in the coming months as Banxico’s hiking cycle is over and the easing cycle could start by year-end, in our view. Regarding strategy costs, for the next six months, the neutral carry cost of a steepening strategy in the 2Y/10Y slope is close to 100bp as a steepening is anticipated. This is also the case with the 2Y/5Y slope, where the carry cost of a steepening strategy is now close to 70bp.
Finally, in terms of FRAs, forwards are below spot rates as markets are shifting to factor in a monetary pause and the start of an easing cycle. Spreads between FRAs and spot rates at the very short end of the curve (6 to 9 months) remain close to zero but trending downwards as FRAs have decreased more than spot yields. Spreads in the 1Y/1Y vs. 2Y TIIE and 3Y/2Y vs. 5Y TIIE remain negative, so paying the forward rate and receiving the spot rate continues to be attractive in those sections. Considering current valuations, we still see good prospects of capitalising the distortion between FRAs and spot rates from the 1Y to the 5Y.