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Eric Theoret: Welcome to Market Points. I'm Eric Theoret, FX Strategist at Scotiabank in Toronto. We're recording on October 28th, just after the Bank of Canada raised its policy rate by 25 basis points to 2.5%, and the Federal Reserve left rates unchanged at 4%.
Joining me on the podcast from Mexico City is Ricardo Bravo Gomez, Fixed Income and FX Strategist. Ricardo, great to have you.
Ricardo Bravo Gomez: Thank you very much, Eric, and really nice to have this conversation and really happy to talk to you.
ET: It's been a busy day for North American currencies, and I wanted to start with how markets have reacted to today's announcements. It seems like the initial market reactions to both the Bank of Canada and the Fed announcements were relatively muted. Although I would say it, maybe a relatively greater a reaction to the Fed specifically, where we saw quite a bit of weakness broadly against all of the G10 currencies, including emerging market currencies through the press conference.
And I was wondering, is this something that you saw in the Mexican peso as well?
RBG: So Mexican peso today reacted quite mutely. I mean, it was a pretty stable move because it was already priced-in in the market right now. I would say that even though we saw some appreciation move towards the press conference of the Fed chair Kevin Warsh, I would say that most of it has to be related with the announcement of the calendar changes on the FOMC for next year.
But as of now, we don't have specifics of which meetings will not have rate decisions, and also how this will impact or have the implication on the financial markets for 2027 specifically.
ET: Canada and Mexico have had a, I would say, a historically connected relationship in terms of monetary policy. Different trajectories overall, but at the same time, I would say more coordination just owing to geographic proximity.
So I wonder, do you think that this development at the Fed, and specifically the kind of the removal of two voting meetings, could have some repercussions for Banxico and the Bank of Canada?
RBG: It will have some implications in the long run. We will see how monetary policy path goes into 2027. Pricing in the market right now is around two hikes for the Federal Reserve, and for Mexico it's quite more of a sharper move on that part.
We're thinking, or at least the market is thinking around 100 basis points of hikes for 2027, I mean, on a cumulative basis, and also we will have to see how this comes into play given the removal of these two meetings. It was a pretty atypical announcement from the Federal Reserve, right?
ET: Yes. And I mean, it certainly feels like we didn't really have any kind of trial balloons or any, any of those kind of pre-meeting, you know, releases and kind of secret indications of things to come that prepare markets for these situations.
I mean, I guess the other piece is the sequence of it, right?
So we have one non-statement, non-voting meeting in 2027. We got two in 2028. I was joking with my colleagues, do you think this could extend sequentially year by year until we end up with no voting meetings in 12 years? I mean, it's just it's overall, it's a funny thing to, to roll out, again, without really preconditioning markets.
RBG: And actually, you're completely right about it. Right now the market, it's kind of digesting the announcement. It's kind of thinking what's going to be the implications for not only U.S. market, but also as the global markets as a whole. And also, it will be real interesting to see if there's a response in Banxico, but also in the emerging market central bank complex.
ET: You know, it's interesting to think about this surprise scheduling announcement within the context of things that, you know, we already know that central banks have either done or not done together, right? If the Fed is kind of leading the charge on this, they've already somewhat led the charge on forward guidance and the removal of forward guidance.
And I know, certainly some other central banks may have not as taken as much of an explicit approach, but they certainly all seem to have kind of dialed back their messaging and their engagement just in terms of really preparing markets and allowing things to operate on a going forward basis.
Now, for the Central Bank of Mexico, I was wondering if you could explain, recently we did get some messaging around the policy path and the potential for divergence to the Fed. Do you see that as a form of forward guidance?
RBG: Banxico at least on the last couple of minutes, on the last couple of meetings, they have been pretty vocal around what they are thinking about, what they are trying to do in order for them to see a convergence of inflation.
And also I would say that this will remain somehow the same for Banxico later on. I mean, right now we're thinking about Banxico as a vocal central bank, and also that's one of the things that has proven to be very efficient in, in how a market is pricing the monetary policy path for Mexico as of now.
As you said it once again we have seen this Federal Reserve change. And also we have seen how the market is trying to adapt in this new environment of pretty limited forward guidance. And therefore, we will have to see the efficiency of these kind of measures in order to see if the Banxico will try to change on that part.
But as of now, I'm not thinking about it. I don't think that even the, the board of governors are thinking about limiting the forward guidance. And I think it has been a pretty efficient tool for them to express their opinions and also the monetary policy path for Mexico going forward, right?
ET: Now, I was wondering if, maybe we might switch to the kind of the broader story and maybe the more kind of medium-term time horizon for FX. I think just to set the stage, I think at the, the top level, kind of U.S. dollar level, the big dollar, we've seen a pretty notable rollover in the DXY and any kind of measure of broad U.S. dollar indices. Since I would say maybe mid-October, so the last couple of weeks, right?
A lot of it kicking off in the aftermath of the September Fed meeting. I think expectations got very aggressive in terms of really building in a very aggressive tightening path. And since then we've had policymakers at the Fed, specifically the New York Fed president, members of the board of governors, what we'd call heavy hitters.
The voices that you want to pay attention to really just dampening these expectations for hawkishness, saying, “We're still looking to do some tightening, but, we might not be as aggressive about it.” and again, I think, the interesting developments today in terms of the Warsh press conference was very much one in which, I don't want to say future hikes were called into question at all.
I think there's, there still seems to be a nominal bias to tightening. But at the same time, they're not in a rush. They've got task forces to reveal. I think we got indications that they'll be looking at the balance sheet task force, the employment and productivity task force, we'll be getting a report of some kind.
Now, I'll do a quick wrap-up of the CAD before we go on to the MXN, because I think for the Canadian dollar it's been a rough ride for the CAD bulls, of which I count myself to be one of them. We've been struggling with things like trade policy uncertainty.
I think an overall kind of concern about the Bank of Canada's basically willingness to deliver tightening in an environment of uncertainty. And yet, I think, in the September meeting, we certainly got, preparations for a future hike. We see that, things like trade have been diminished, in kind of opposite to, I would say, energy prices and inflation more broadly.
So just downside risks versus upside risks. And so overall, you know, I think in the same period where we've had the U.S. dollar rolling over the past couple of weeks, we've had the CAD strengthening. And I think just generally it feels like, not only the CAD, but most of the G10 currencies will be seeing strength.
The Mexican peso, I think we were at two-year highs somewhat recently, and then we had a pretty dramatic sell-off, the reversal that we recently saw was pretty notable. Can you give us a rundown?
RBG: The Mexican peso, I would say 2025, we have pretty aggressive interest rates around 11.25%, which provided a spread against the U.S. treasuries of around 550 basis points. This spread has been diminishing given the disinflationary process that we have seen in Mexico, where right now inflation has been around the variability range of Banxico nowadays.
For emerging markets, I would say carry trade is really, really important in a way that somehow it provides a little bit more in terms of the analysis of the Mexican peso and not as fundamental as, for example, G10 currencies on that side.
I would say that this spread even getting as tight in as 275 basis points or even 250, I would say it's pretty tight on a historical level, and also is one of the things that has provided this weakness into the Mexican peso nowadays. I think that the main event that somehow made this divergence of the Mexican peso is specifically, as you said before, September FOMC meeting and also September minutes for Banxico.
As we might recall, September was a meeting in which the Federal Reserve increased by 25 basis points and Banxico in their minutes even provided guidance of going into an easing cycle for the next foreseeable future.
Therefore, the carry trade, note specifically the Mexican peso, suffer a lot of volatility. And this somehow has been one of the main factors for it to depreciate quite sharply. And I would also like to add that on a relative basis you have Brazil, Colombia, that provides a more interesting interest rate on that part, and that's why we have seen this differentiating factors on LatAm and also on emerging markets.
And one point I would really like to add on that part is that in terms of forward guidance, Banxico has been the I would say, the more dovish central bank relative to some other emerging market central banks, as I said before. Therefore this weakness is provided or is explained specifically by the carry trade and how the trends are pointing toward tightening in the spread and also some other currencies being more appealing or more attractive on given this factor, right?
ET: I'll be quite honest, I was a bit surprised to hear that, there was a, I guess the discussion was open, or at least the option was left open, that rates in Mexico could be declining because I think, you know, obviously we're in a world where, the Fed has raised, the ECB has delivered two hikes, we've got a Bank of Japan that's also tightening and looking to do more.
It's interesting to see that there are some countries, some central banks that can be moving in the opposite direction in this world of elevated energy prices. So I know you mentioned that we've had disinflationary trends in Mexico. I mentioned that the peso was at two-year highs before this latest sell-off.
So what's allowing this disinflationary, impulse to kind of carry on in Mexico in stark contrast to other economies around the world?
RBG: I would say that in Mexico we have seen that the inflation has not been impacted by oil prices as in some other geographies around the world.
Most of it has been related because the government has subsidized diesel prices and some gas prices in the country, and therefore the impact has been pretty much limited.
Now, the other thing is that – Mexico has been growing on a very modest pace and this growth has also provided some room for Banxico for it to have inflationary pressures on the services side and specifically on the core side of inflation right now.
On a base effect on an annual rate, we have seen inflation declining and that's one of the things that has provided room for Banxico to tighten, as I said before, the spread against on a relative basis and also to keep the easing cycle since 2024 to a couple months ago on that side.
But I mean, I know that in Canada, I know that in some of other geographies, the impact or the pass-through from oil prices has been huge and therefore there's a lot of concerns going on in terms of inflation. So, it's quite interesting and the contrast between the geographies is really important.
ET: I think, contrasting the, the Mexico, experience with what we're seeing in Canada, the U.S., and obviously most differently and really stark contrast with Europe. Canada, an energy economy, U.S. also a major oil producer. And I think when you spoke of diesel specifically being subsidized in Mexico, you know, I know that's been very much a kind of a pain point for Europe.
So, it is interesting to see the different approaches that governments are taking to this. And I think, particularly interesting to see Mexican strategy because at the end of the day, if they're insulating themselves from energy prices then they're kind of mitigating the inflation cost and then there's a monetary policy implication as well.
RBG: One of the things that is also worth mentioning, is that even though we have seen pretty limited impacts from oil prices, we're also importers of some products and some derivatives of oil products. So in that side we will see some second-round effects or some secondary effects on that part that we're expecting to see a rebound on inflation going forward.
ET: Trade has been an interesting topic, but I would say that, it seems like in terms of the I guess the tenor of negotiations the, I guess the approaches were somewhat different. And yet it seems like, at least in recent weeks the Canadian situation's going a little bit better.
Are trade policy developments still impacting the Mexican peso? I feel like even with Canada it's hard to pin recent performance as being driven by headlines to the extent that it was.
RBG: Mexican peso has proven to be a little bit more resilient to the headline trading towards trade, as you said before.
And also it's really worth mentioning that we have not seen a huge sensitivity of the Mexican peso into this headlines because, as we spoke before, some other risks are, are floating the Mexican economy right now. Of course, this is huge, and trade is huge for Mexico because we are a pretty much integrated or the most integrated region in the world in terms of trade.
And this is also a big thing or concern for manufacturing in Mexico as of now. Most of the government officials has pointed that we might see some news in the Mexico side with the U.S. in terms of trade after midterm elections. But there's a lot to be seen, and there's a lot to be proven in this, I would say, trilateral agreement with Canada also, and how this scheme of the three countries will somehow live in this context of a more protectionist approach on trade in the world, not only in North America, right?
ET: Right. You know, I wanted to kind of move on to the next broader topic. How we approach FX markets and, and the different perspectives that we bring to them, whether from, you know, our experience or just the our processes, right?
I think definitely, we, we switch lenses when we're kind of looking at markets. Sometimes it's fundamentals, sometimes it's sentiment. I know on a day like today, obviously we've had the short end of the U.S. curve, the two years down five basis points. The quick and dirty for us is, looking at two-year spreads between the U.S. and Canada, that's positive for the Canadian dollar, so dollar Canada lower.
So the outlook for relative central bank policy definitely seems like the kind of the iron rule that kind of dictates movement among the developed economy currencies. But you mentioned earlier the concept of carry and its role in driving the Mexican peso. So, maybe just giving us a better sense of, how there are overlaps in terms of fundamentals or if, if there are any at all. In terms of how we would look at, again, interest rate differentials, the outlook for relative central bank policy, and then where things like carry do kind of come into play for Mexico. And if that's something that, at least from your perspective, do you ever see in the developed economy currencies?
I'm thinking maybe Aussie, maybe Kiwi. But I'll leave the floor open to you to kind of give us the rundown.
RBG: In the EM complex you kind of hear that carry is the king, and that has been the case for the past two or three years for the EM FX on that side.
I would just add on that part that, as you said before, sometimes you switch from fundamentals to, let's say, economic developments, news, spreads. I mean, and this changes quite drastically in the EM markets. A few years ago, remittances were a really important factor for the Mexican peso movements on that side.
And right now, it doesn't seems to be the case because flows are more into the financial markets, more into the carry trade rather than the fundamentals nowadays. Of course, I do believe, and I'm a huge believer, that we mean reverse into fundamental, but somehow in this context in which carry trade right now, it's doesn't look that appealing in the Mexican peso, it's going to be a vulnerability for the currency right now.
And we will see how this develops and how much will Banxico will try to, let's say, influence on that part. So nowadays doesn't seem to be a lot of fundamental going on into the Mexican peso, but that doesn't mean that in the future we will see a reversal once again. As we have spoken before, growth has been somehow slacking. We have seen some, or we are somehow seeing inflationary pressures in the future, and that's the factors that will have to come into play later on when this carry trade factor dissipates in the market.
I mean, I will just ask you if you think that is the same for G10 currencies, because I know that fundamentals, or at least in my opinion, fundamentals come more into play in the G10 spectrum rather than the EM market.
ET: When I come into the office in the morning and I'm trying to figure out do fundamentals matter or not I kind of just have to look at things like the market tone, right?
The VIX, the equity market volatility index, and just I would say the broader performance of currencies. You know, you can tell when the yen and the Swiss franc are outperforming, and Aussie and Kiwi are underperforming. Those are environments where, yeah, the sentiment is definitely dictating the market tone.
And so fundamentals, I would say matter when the skies are clear, the sun's shining, got a blue sky. Fundamentals, kind of get thrown out when you're in a world of, thunderstorms and hurricanes and tornadoes. And that's, where you just want to find a shelter.
There can be a day where, you get a solid GDP report, maybe a CPI release that should give you a certain indication as to how things should go. But if it's happening in the context of, Brexit, a bank failure, any of these kind of financial market events, it really just doesn't matter. And so I think the context is key. But, overall, it does feel like markets, and, and maybe it's a by-product of the forward guidance era and just the dispersion of information that is just still asymmetrical, but maybe not as asymmetrical as it used to be and, and just, and will get priced immediately, right?
So I feel like there's just less scope for kind of big misalignments in terms of information when, when something hits, it might already have been in the price.
RBG: One of the things that I will just add on that, and I think that it's going to be the case for both of EM, but also G10, is the positioning.
I think the positioning has a huge role in how the currencies perform, and also that's one of the things of how as you said before, market sentiment comes into play on that part.
ET: Given that we are talking about fundamentals and sentiment, we might leave off and kind of wrap up the conversation with a, you know, a level setting of fundamentals.
So Scotiabank, we just released our latest forecast, and we've extended our forecast horizon to 2028, so a bit of a longer timeframe in which to consider all of these fundamental developments. I think just looking at least from my perspective in terms of the broad U.S. dollar forecast we have a bearish U.S. dollar view.
So we're expecting weakness against all of the major G10 currencies. USD/CAD ending this year at 139, next year at 134, and at the end of the forecast horizon, 2028 at 133. So expecting some, I would say, pretty important CAD strength over the next year or so and tapering off towards the end of the forecast horizon. But, a lot of that is driven by the outlook for relative central bank policy, again, getting back to those, fundamentals that are so critical for Canada and G10 currencies.
We bumped up our hawkish Bank of Canada forecast. We added a fourth hike, so for a cumulative 100 basis points, of which we got one 25 basis point hike today, so 75 to go.
And for the U.S., bumped up by one, but, it's just looking a bit more circumspect after the messaging that we got from Warsh today. And it wasn't exactly a wink, but certainly a bit of a smirk that gave us a sense that those expecting additional hikes might be waiting a while as they work through things like disinflation in the narrower measures of the PCE as well as the, the really, I think, important implications of the task forces that are still, working across five very different vectors that will inform the Fed's approach to policy over the medium term.
And then finally, of course, this kind of surprise scheduling change in terms of removing the significance of one policy meeting at the Fed in 2027 and two policy meetings in 2028. So, I guess in terms of the Fed forecast, like I said, we've got a bit of tightening priced in. Not sure, again, after today how much of that we'll get.
But the other interesting piece for the Federal Reserve forecast has been the introduction of 75 basis points of easing in the back half of our forecast horizon, which again, does quite a bit of heavy lifting in terms of driving how we look at things, which is interest rate differentials, and narrowing those differentials in a way that really is eroding a fundamental pillar of support for the U.S. dollar.
So that's the bearish U.S. dollar view in a nutshell. But could you please walk us through the, the Mex forecast?
RBG: So for the USD/MXN forecast for 2026, we're expecting 18.39 pesos per dollar. Right now, as I said before we're having a lot of vulnerabilities, and therefore the risk of a depreciation might be even further.
But as of now, 18 39 is going to be our official forecast for 2026. For 2027 it will drop, or it will go as high as 18.90- 93 for, for our official forecast. And that's also kind of our sense into the depreciating move as we discussed before, given all these variables along the narrower spreads with the U.S., with some other developed markets, and therefore some bearish bias towards the Mexican peso.
For Bank of Mexico, we're still expecting 650 for 2026, also for 2027. And once again, there's a lot of risk going on into the market in terms of inflation, in terms of the relative stance with the Federal Reserve, with some other central banks. And we will have to see how the macro environment goes as of now.
ET: All right. Well, I think, that's a great place to leave it. Ricardo, I just wanted to thank you for joining me today.
RBG: Thank you very much, Eric, and really nice talking to you.
ET: And for our listeners, thank you for joining us as well. For a copy of the latest forecast, please reach out to your Scotiabank representative.
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