Banco de Mexico (Banxico) recently shared the minutes from its meeting on September 25, where it lowered interest rates by 25 basis points to 7.50%. This is the lowest rate since May 2022. Notably, Deputy Governor Jonathan Heath opposed the decision, warning about potential inflation risks from proposed tariffs on imports from China. The minutes suggest that Banxico may consider more rate cuts. They plan to evaluate key economic factors like the USD/MXN exchange rate and the impact of tariffs. Many board members noted that inflation is currently below the historical average, although some are concerned about how livestock product price shocks affect core inflation.

Impact of Interest Rates on the Mexican Peso

Banxico’s goal is to protect the value of the Mexican Peso and keep inflation around 3%. The bank adjusts interest rates to achieve this, with higher rates typically boosting the Peso by attracting foreign investment. The bank meets eight times a year, usually shortly after the US Federal Reserve’s meetings, which influences Banxico’s policies. Banxico’s actions are closely tied to the Federal Reserve’s decisions. For example, after the Covid-19 pandemic, Banxico raised rates to prevent the Peso from losing value. The minutes from the September 25 meeting indicate that most Banxico board members are open to cutting rates again after lowering them to 7.50%. This view is reinforced by the latest inflation report showing headline inflation dropping to 3.8% in September, closer to Banxico’s target. As a result, markets are now expecting a higher chance of another 25 basis point cut at the upcoming meeting in November.

Possible Effects on the Peso

For those trading the peso, this shift in tone suggests it may weaken further against the US dollar. Since the late September rate cut, the USD/MXN exchange rate has increased from about 17.80 to nearly 18.15. With the US Federal Reserve keeping its rates steady for now, the attractive interest rate difference that has supported the peso in early 2024 is narrowing. Traders might want to prepare for a weaker peso. Strategies like buying USD/MXN call options or call spreads could be beneficial, especially if the central bank decides on another cut. Recent data shows Mexico’s IGAE economic activity index slightly contracted in August. While implied volatility on peso options has risen a bit, it is still lower than the peaks seen in 2023, indicating that protective strategies remain reasonably priced. It’s important to note that the decision to cut rates wasn’t unanimous, highlighting a risk for short-peso positions. Deputy Governor Heath’s worries about potential inflation from the proposed tariffs on Chinese goods add uncertainty, especially since last week’s trade talks did not lead to a clear solution. Any unexpected rise in inflation or sudden implementation of tariffs could lead Banxico to pause its rate cuts, which might cause the peso to reverse course sharply. Create your live VT Markets account and start trading now.

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