Mexican Peso Outlook: Banxico Seen Hiking Rates Again. How will USD/MXN React?

(MENAFN- DailyFX) BANXICO KEY POINTS:

• Banxico is expected to raise borrowing costs by 25 bp to 4.75% on Thursday, in what would be the third consecutive rate increase
• With the hike already discounted, traders will be more interested in the policy statement as the document may offer clues about the tightening cycle
• Tighter monetary policy in Mexico is likely to be positive for the Mexican peso over the medium term, but in the short run, U.S. treasury yield dynamics and general market sentiment will set the tone for price action

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Banxico is scheduled to announce its September monetary policy decision on Thursday. Investors widely expects the institution led by Alejandro Diaz de Leon to raise the overnight interbank rate by 25 basis points to 4.75% in an effort to tame red-hot inflation and prevent upside risks from materializing. The hike, which would be the third in a row, has already been discounted, so it is unlikely to be a major market-moving event for USD/MXN in and of itself, though the statement bias could be important as it may offer clues about the trajectory of the tightening cycle.

Circling back inflation, in the first half of the month, headline CPI stood at 5.87% y/y while the core indicator jumped 4.92% y/y, rising well above the 3% mid-point goal in both cases. At the same time, both metrics accelerated with respect to the previous fortnight, particularly the underlying gauge, a sign that inflationary pressures continue to broaden in the Mexican economy despite some price control measures implemented by the government.

With the consumer price outlook failing to improve noticeably, medium-term expectations could begin to de-anchor, complicating the central bank's efforts to ensure CPI converges to the target over the policy horizon. For this reason, Banxico is likely to remain cautious and leave the door open to additional rate hikes in the fourth quarter, should incoming data warrant such action.

Any sign that Banxico is willing to pull the trigger and tighten monetary policy again in upcoming meetings will be viewed as a hawkish signal and create a constructive backdrop for the Mexican peso over the medium-term. In the short-run, however, external factors, namely U.S. yields dynamics and general sentiment should be more relevant for the Mexican currency.

In recent days, rapid increases in US Treasury rates following the September FOMC meeting have created turbulence in many asset classes, bolstering the US dollar and weighing on EMFX. If disorderly moves in the bond market continue heading into October, volatility will stay elevated and risk-appetite subdued. This, of course, could bias USD /MXN to the upside, as traders normally increase defensive positions in times of market turmoil.

After breaking above trendline resistance earlier this week, USD/MXN has pushed higher and climbed towards 20.50 amid renewed buying interest. If bulls manage to drive prices above this key technical barrier decisively, upside pressure could accelerate and pave the way for a move towards the June high near 20.75. Alternatively, USD/MXN pivots lower, the first support appears at 20.20. A break below this floor could expose the August and September low in the 19.80 area.

Source: TradingView

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---Written by Diego Colman, DailyFX Market Strategist

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