The TIIE curve has moved to incorporate a more hawkish stance. Indeed, markets have moved to price in a terminal rate close to 12.0% compared to 11.25% three months ago. As a result, the TIIE curve has maintained its inverted shape: at the very short end (until the 9M tenor) the market expects more hikes from Banxico, and cuts are priced in along the rest of the curve, starting from one year.
The curve has continued to flatten/invert further, and while the movement has been quick and aggressive, volatility could prevail. In our view, the reasons for an inverted curve remain, and the process of normalisation could take more time.
We therefore maintain our preference for the 5Y-7Y section in nominal rates as monetary uncertainty could be less reactive than at the short end of the curve, in which the market will continue to price a restrictive approach from Banxico. In addition, because of convexity, that section shows an attractive return, which is why we stand pat on our recommendation. A steepening of the curve might take place into the 2H23 as we enter in a monetary pause; however, in the near term we expect negative slopes to prevail.
Starting from the 2Y tenor, spot rates have moved more than FRAs with the recent hike from Banxico. Spreads between FRAs and spot rates are negative and have shifted downwards. Indeed, in the 2Y-10Y section, spreads are at minimums, which enables paying the forward rate and receiving the spot rate. As we remain constructive in the 5Y-7Y section, we see room to take advantage of the current distortion between FRAs and spot rates and recommend receiving the 5Y spot rate and paying the 3Y/2Y FRA as the spread currently stands close to -130bp, which is an historical minimum.