The Mexican Economy Shrank By 1.2% In Q1

Mexico's elections to be held on 1 JulyAndrès Manuel Lopez Obrador is favourite candidate to be Mexico's next leader

Olivia Álvarez (Monex Europe) | The Mexican economy shrank by 1.2% in Q1 on a quarterly basis, or 1.4% when compared with last´s year same period (not seasonally adjusted). The fallout in Q1 follows a series of 5 quarterly contractions over the last year and a half, further deepening the ongoing economic recession in Mexico. The coronavirus shock is mainly to blame for the Q1 contraction as external demand dropped sharply, with domestic activity only being affected in the last week of the quarter by the implementation of social distancing measures. Even so, quarterly GDP was dragged down to its worst performance since the financial crisis in 2009, with the March GDP contraction of 1.25% adding to a monthly decline of 0.59% in February and stalemate in January. Measured by economic sectors, both manufacturing and services contributed negatively to the overall data, with quarterly declines of 1.2% and 0.9% respectively. The primary sector, in turn, advanced by 1.7% during the period, probably aided by lower food prices.

The data release helped to boost the peso, however, as the market consensus was pricing in a worse 1.6% QoQ% contraction. After losing over a fourth of its value since the beginning of the year, the currency had already discounted most of the bad news and was prepared for a bleak outlook becoming a realisation, including a sovereign credit downgrade by three main rating agencies and Pemex´s downgrade into further junk territory. The median forecast for Mexico’s annual economic contraction is 7% for 2020, while the economy isn’t expected to bounce back until mid-2021. Underwhelming fiscal support aimed towards the economic recovery and the inability of monetary policy to act as a stimulus tool on its own doesn’t help to raise expectations from their current depths.

Despite the negative outlook for the Mexican economy, the peso finds itself at a turning point as economic activity resumes and market sentiment eases. Banxico´s hawkish stance compared to other central banks in emerging market economies stands as a support for the currency –the CB holds the fifth-highest policy rate among peers, while domestic inflation sits within the target range. The Mexican peso also accounts for the largest trade volumes across the Latin American space, benefiting from high carry-trade profits in low-volatility environments. That means the currency stands good chances of leading gains among emerging peers as markets return to risk-on dynamics as global uncertainty subsides. The currency has already advanced for 7 consecutive sessions over the last week, with markets turning more complacent on the back of easing lockdown measures worldwide. This is most notable in today’s session with the prospect of rising US-China tensions being swept to one side as markets favour positive news coming from Japan’s relaxation of lockdown measures. Provided that this narrative consolidates in the following months, we could expect the Mexican peso to return gradually towards its pre-virus levels by the end of next quarter, although within a wider volatility range. However, this scenario rests on a notably high uncertainty as the US-China spat could derail increasing financial stress and subsequent risk-off moves.