Inflation to remain high, keeping Banxico vigilant
Banxico’s Minutes (August 11th). In the last decision, the Board increased the reference rate by 75bps, taking it to 8.50%. The vote was also unanimous, with the statement remaining hawkish. Despite of the latter, we noted relevant changes in terms of the possible actions ahead. In particular, they now consider that the magnitude of upcoming hikes will depend on “prevailing conditions”. As such, our attention will center on member comments over which could be said conditions. In our opinion, they will be related to: (1) Inflation levels –both headline and core; (2) the relative monetary stance with the Fed; and (3) to a lesser extent, the outlook for economic growth. We will remain watchful on the discussion over inflation, especially after recent comments from some members that suggest that the cycle high is close. Finally, we will seek information over which could be the terminal level for the rate, either in nominal terms or relative to the estimated, real neutral level
Inflation (1H-August). We expect headline inflation at 0.33% 2w/2w. The period will likely be characterized by additional pressures in processed foods, along with cost passthrough to some services, and a favorable seasonal effect in touristic categories. We anticipate an acceleration of the core at the margin, to +0.37% (contribution: +28bps). The non-core is expected to increase 0.19% (+5bps), benefitted by some stability in energy prices. With these estimates, annual inflation would increase to 8.52% from 8.15% on average in July. Meanwhile, the core is seen as maintaining an upward trend, reaching 7.85% from 7.65% previously
Proceeding in chronological order...
Weekly international reserves report. Last week, net international reserves increased by US$91 million, closing at US$199.4 billion. This was mainly explained by a positive valuation effect in institutional assets. Year-to-date, the central bank’s international reserves have fallen by US$3.0 billion.
Core inflation to stay high in the 1st half of August, with the headline less so on more benign dynamics at the non-core. We expect headline inflation at 0.33% 2w/2w. The period will likely be characterized by additional pressures in processed foods, along with cost passthrough to some services, and a favorable seasonal effect in touristic categories. We anticipate an acceleration of the core at the margin, to +0.37% (contribution: +28bps). The non-core is expected to increase at a more modest pace, at 0.19% (+5bps). With these estimates, annual inflation would increase to 8.52% from 8.15% on average in July. Meanwhile, the core is seen as maintaining an upward trend, reaching 7.85% from 7.65%.
On the latter, goods are estimated to grow 0.5%, with processed foods still as the main driver, up 0.6%. Our monitoring showed important increases in bread –without ruling out an influence from the recent upward adjustment in several products made by Bimbo, in addition to higher costs– along with milk and cheese, among the most relevant. In other goods (+0.4%), we note possible pressures in school supplies before the start of the new educational year (with colleges back in the classroom during the first fortnight, while elementary and high school return in the second half). Services would stay relatively more contained, up 0.2% (+6bps). On one hand, tuitions are expected to increase 1.2% (+4bps); on the other, tourism-related categories are seen downwards after the holiday season, with airfares at -13.8% (-4bps) and tourism services declining 5.7% (-2bps). Despite of this, other services would maintain an upward trend, especially in dining away from home.
Going to the non-core, we expect a modest rebound in agricultural goods (0.4%) after falling 0.2% in the previous print. This would be explained by fruits and vegetables (+1.0%). Our price and news monitor flagged strong increases in onions and an additional uptick in potatoes; on the contrary, we observed lower prices in bananas and avocadoes, among the most relevant. Tomatoes were mixed. In meat and egg, chicken was mixed, beef increased, and eggs declined. Energy should be stable (-0.1%). Domestic gas would fall (-0.7%) due to lower international prices and some strength of the peso against the dollar.
Low-grade gasoline (-0.1%) likely benefitted also from these factors, albeit compensated to a great extent by lower government stimulus, with complementary subsidies even reaching zero for both types of fuel by the end of the period. Nevertheless, electricity has been rising, estimated at 1.0%. Lastly, government-administered prices would moderate (0.1%) after a sizable increase in the 2nd-half of July.
GDP in 2Q22 to be revised slightly down on slower services. We anticipate 2Q22 GDP an inch lower relative to the preliminary print, to 2.0% y/y from 2.1%. This would be explained by a revision in services, with a more challenging outlook for June, while industry would remain practically unchanged –as already known–. Considering this, the sequential print would come in at 0.9% q/q (preliminary: 1.0%), marking a third consecutive quarter of improvements after the decline in 3Q21.
By sectors, industry would grow 0.9% q/q (+3.3% y/y), just 1bp below the preliminary print. All through the period, manufacturing has shown resilience amid a challenging environment for trade. In addition, construction has picked-up with some strength, boosted by both public projects and private investment in industrial works. Meanwhile, mining has maintained a more volatile performance, being negative in the quarter. We see services slightly weaker at 0.8% q/q (0.9% y/y), which would imply a revision of -21bps vs. the preliminary print. Specifically, we consider that the effects from higher inflation, the lack of payments from social programs (due to the electoral ban), and rising COVID-19 cases may have impacted performance, especially at the middle and end of the period. Lastly, primary activities are estimated to rise 1.5% q/q (+2.5% y/y), better by +59bps and boosted by a favorable base despite worsening drought conditions and other hurdles for production.
Along the GDP report, June’s GDP-proxy (IGAE) will also be released, which we expect at 2.0% y/y. With seasonally adjusted figures, this would imply a 2.2% y/y expansion. In turn, this would be marginally higher than the 2.1% forecast from INEGI’s Timely Indicator of Economic Activity. In sequential terms we expect 0.0% m/m. As already known, industrial production rose 0.1% m/m (3.8% y/y), boosted by mining and construction. Services would rebound 0.4% m/m (1.4% y/y). This would be quite favorable considering relevant adverse factors in the month, as outlined previously. On fundamentals, remittances and credit kept gathering pace, with a rebound in employment but with a decline in wages Mobility in retail and entertainment sectors was quite stable, although with a relevant hit in workplaces, which we attribute to rising contagions. Consistent with this, sentiment indicators such as IMEF’s non-manufacturing PMI and consumer confidence fell, albeit with the former remaining in expansion territory at 51.8pts. By sectors, retail sales showed a decline of 0.3% m/m in their stand-alone report, although the correlation between this indicator and IGAE has decreased in recent months. On tourism, hotel occupancy rates moderated to 57.2%, an inch lower despite a more favorable seasonality. Similarly, air passenger traffic decelerated by 37.2 thousand to 7.0 million, with the increase in costs for airlines likely impacting performance.
On the other hand, we will keep looking at professional and support services, considering a volatile behavior so far in the year and not ruling out further weakness. Finally, education and healthcare might remain to the upside, similar to financial services.
If these results materialize, GDP would have accumulated an expansion of 1.9% so far in the year. Something that is certain is that, after the strong deceleration in 3Q21, the economy gathered pace in the first half of this year. This is favorable for our 2.1% full year estimate. In particular, domestic demand has surprised favorably. Although signals of a moderation are increasing –given global recession fears and monetary tightening– and are already incorporated in our forecasts, we keep anticipating sequential increases in the second half of the year, with a boost from this factor and with the US economy benefiting our country –especially through remittances, with a labor market that is still strong in said country–. In our opinion, this will likely result in additional revisions from other market participants.
A more modest current account deficit in 2Q22. We estimate a US$2.6 billion deficit (previous: -US$6.5 billion). In the period, high oil prices, strong remittances’ inflows, as well as certain seasonal drivers, likely defined the behavior of the current account.
Based on the trade balance for June, the goods’ balance would again be highly influenced by elevated oil prices and, to a lesser extent, better conditions in global trade towards the end of the quarter. We estimate a deficit in services, explained by higher transportation costs, specifically freight. However, this would be partially offset by foreign currency inflows from international travelers, which would add eight quarters to the upside. Hence, the sum of goods and services balances would show a deficit for the sixth consecutive quarter. On the other hand, we estimate primary income deficit, although more modest than previously. This would reflect both lower outflows and inflows in profits and dividends, remembering its marked seasonality during the first quarter of the year. However, we believe interest income remained strong, partly driven by higher interest rates globally. Regarding secondary income, foreign currency inflows from remittances accelerated –recalling that Mother's Day leads to a significant uptick, implying a strong surplus.
Lastly, the financial account would keep showing net borrowing from abroad –meaning, a net inflow of foreign currency– with foreign direct investment –the main component in terms of magnitude– showing lower inflows than in 1Q22. Meanwhile, portfolio investment flows would continue to reflect outflows, with purchases of foreign assets by residents increasing even more, exacerbated by the sale of local instruments by foreigners.
Banxico minutes to shed light on the “prevailing conditions” needed to assess the magnitude of upcoming hikes. In the last decision, the Board increased the reference rate by 75bps, taking it to 8.50%.. The vote was also unanimous, with the statement remaining hawkish. Despite of the latter, we noted relevant changes in terms of the possible actions ahead. In particular, they now consider that the magnitude of upcoming hikes will depend on “prevailing conditions”. As such, our attention will center on member comments over which could be said conditions. In our opinion, they will be related to: (1) Inflation levels –both headline and core; (2) the relative monetary stance with the Fed; and (3) to a lesser extent, the outlook for economic growth. We will remain watchful on the discussion over inflation, especially after recent comments from some members that suggest that the cycle high is close. Finally, we will seek information over which could be the terminal level for the rate, either in nominal terms or relative to the estimated, real neutral level.
Since the decision, we have had public participations from Governor Victoria Rodríguez and Deputy Governors Gerardo Esquivel and Jonathan Heath. The former, as it is usual, had interviews with several outlets after the decision. We consider her most relevant comments were in an interview with Expansión. On recent dynamics, she argued that “…the bank’s actions, along the fading out of the shocks that have stemmed from the pandemic and the war, will allow inflation to start declining and converge to the target as we expect it…”. Just on this point, Deputy Governor Esquivel expanded further. In his participation with Enfoque Noticias, he mentioned that “…it is likely that we reach the highest point for inflation in August or September of this year, a level a little higher than what we have right now…”. This is quite in line with our expectations, seeing a high of 8.73% in the second half of August. On the convergence to the target, he commented that “…it will be a long, gradual process, but we expect that the disinflation process, meaning a reduction in the rate of inflation, starts to happen as soon as this quarter…”. We believe these comments suggest that he would be willing to delay the moment in which Banxico could decouple from the Fed, remembering that, in the previous minutes, he had set them in some point of 3Q22.
Lastly, Deputy Governor Heath had similar comments in his interview with Radio Fórmula, commenting that “…wishfully inflation reaches its peak in the third quarter of this year, from there a downward trajectory would start […] I can say that it will be a very difficult, very fragile, and very prolonged…”. On the risks for the path ahead, he added that “…if we look ahead and we make a balance of risks, there is a considerable skew for factors that could result in higher inflation than the one we are projecting…”. In this context, we think that he remains as one of the most hawkish members and even the one most skewed to this side of the spectrum. Therefore, we believe he might prefer to miss on the side of larger tightening, than disappointing in this front.
Considering these comments, we believe “prevailing conditions” will be forcefully tied to the path and inflation expectations, especially the results relative to the central bank’s estimates –which were revised higher once again–. Also, if we see a moderation in the annual rate before the next decision. Although we agree with the latter, we differ in the likely pace of moderation given that, in our opinion, the path will likely show more resistance to return to the target relative to the one outlined by the central bank. Nevertheless, and although it was not highlighted in the statement, we believe another key factor will be the actions taken by the Fed. Our estimate is for +75bps on September 21st, with the market assigning a probability of around 55% to this scenario vs 45% for +50bps. Finally, on the terminal rate, we will continue to look for comments on the subject given that members have not been as vocal so far on this subject. Nevertheless, we do not rule out a larger focus on this considering that the ex-ante real rate is already in restrictive territory after this last decision.
Overall, we believe the document will be relevant to define in a better way the parameters that could influence decisions ahead, providing additional clarity over the fine points in the statement. We remain convinced that the tone will remain hawkish, with the Board preferring to remain very cautious and continue with the foot on the gas in terms of the pace of restriction –at least for September– to reaffirm their commitment with the mandate and influence inflation expectations. Therefore, we maintain our estimate of a 75bps increase on September 29th and a terminal rate by the end of the year at 10.00%.
A wider trade balance deficit in July on improving conditions and seasonal trends. We estimate a US$4,256.3 million deficit, increasing relative to the -US$3,957.2 million seen in the previous month. Exports and imports would grow 19.4% and 18.3% y/y, respectively. Despite a moderation in some commodities’ prices, these remain quite high in annual terms, boosting figures as they are measured in nominal terms. In addition, flows could be supported further by higher volumes shipped, driven by less COVID-19 contagions in China and other logistics improvements worldwide.
In oil, we anticipate a US$3,565.9 million deficit, moderating after increasing sharply in June. We see overall flows inching lower on price declines, albeit more so on imports than exports. In this sense, the former would stand at +52.8% and the latter at +40.7% y/y. Regarding shipments abroad, the Mexican oil mix stood at 96.16 US$bbl (+40.4% y/y) from 109.84 US$/bbl (+62.5%). However, and helping explain a lower deficit, volumes seem to have picked-up, especially to the US. Inflows would also be more modest, especially on consumption goods due to: (1) A sharp decline in front-end gasoline futures; (2) reports of lower exports from the US and ship bottlenecks waiting to offload fuel in Mexican terminals; and (3) lower mobility amid the surge in COVID-19 contagions early in the month, especially to workplaces.
On the other hand, we expect a US$690.3 million deficit in the non-oil balance. Seasonal trends show either a small surplus or a deficit in this type of flows in this period. Exports and imports would grow 17.8% and 13.9%, in the same order. In the first, agricultural goods would stay strong (7.5%), with adverse conditions for production in the US boosting both volumes and prices.
Non-oil mining will remain weak (-29.5%) considering an additional sequential decline in prices. In manufacturing, autos (28.5%) look to have gained dynamism, with AMIA figures suggesting an acceleration in annual terms, while production soared in the US. Signs in ‘others’ are also positive (15.5%), with overall US industrial production stronger, including in the ‘imports’ component within the manufacturing ISM. In imports, flows from China normalized further, while higher dynamism in the US could also impact shipments positively. In this context, we expect consumption goods’ imports at +20.2%, boosted from more favorable conditions domestically. Intermediate goods would decelerate slightly to 13.2%, which would not be that bad when factoring in strength in the previous month. Lastly, capital goods could moderate (13.6%), partly impacted by a slight depreciation of the MXN.