viernes, 22 de mayo de 2009

What Are Rates Trying To Tell Us? (Columna The News)

Money talks.

That is a common phrase in English that you don't find in Spanish. And if money does talk, listening at the long end of the yield curve in Mexico must make Mexico's financial authorities a little bit nervous. That's because what money is trying to tell us is that there is something not completely right with the way monetary policy is being conducted in Mexico.

First let's look at the evidence.

Since January, the central bank has lowered short-term interest rates by as much as 300 basis points, from 8.25 bps, to 5.25 after last week's rate cut. During the same period, rates for long term bonds have barely budged: the rate for the benchmark 10-year bond has dropped from 7.68 percent on Jan. 2, to just 7.54 percent at last Tuesday's close (it is even higher from the 7.42 percent seen on Jan. 9).

Some parts of Mexico's yield curve have reacted more in consequence with Banxico's monetary policy: Rates for the 3-year notes have dropped nearly 190 bps so far this year, but long-term rates remain stubbornly high.

That is a big issue for monetary policy. Although rates offered by banks and credit institutions to private and corporate clients are set after the very short-term Tiie rate (Mexico's interbank rate), the margin charged over Tiie depends wholly on where the long end of the curve is, because that is where the swap is fixed.

Let me explain: If you want to buy a house or get a loan for your business in Mexico, you would need to agree with your bank on the long-term rate. The bank goes to the market and gets long- term financing (for a mortgage, typically 15 years), and charges its funding rate plus its profit margin to you.

Based on the pattern seen in long-term rates in Mexico since the end of this year, it is easy to see why construction and overall credit to durable goods - both of which require long-term financing - have failed to follow on the footsteps of Banxico's aggressive easing.

Investors in long term bonds have not been enticed by Banxico's easing, and there has been an absence of takers of long-term risk in Mexico, who are the ones who must eventually buy long- term bonds in order to reduce long-term rates.


The main reason is inflation. The April CPI data showed inflation not only easing amid a horrible drop in aggregate demand and economic activity, but actually increasing any way you want to measure it - from March, as well as compared with April of last year. Inflation eats on nominal interests paid by bonds, so the outlook of persistently high inflation in Mexico is the main reason why investors are staying away from long term bonds.

The overall systemic risk. You can see this from two different angles: The big ratings agencies have lowered credit outlook for Mexico, with S&P placing the country's finances on credit watch "negative" with a possible downgrade (not too likely at this point) looming on the horizon. Coinciding with this impact on ratings comes the disturbing situation in the country's mortgage industry, with two mortgage banks (Sofoles Metrofinanciera and CrAcdito y Casa) in nearly terminal conditions with fears of the malaise spreading through the sector.

Finally, if any of the above risk factors materialize, the exchange rate may reverse its recent course.

Long-term bond investors are not bullish, as is clear from the figures reported at the onset of this article, but not only in Mexico.

As of last Tuesday's close, the difference between overnight rates (0.0 percent) in the United States, and 10-year (3.125 percent) and 30-year (4.250 percent) bonds in the United States, was 312 and 425 basis points, respectively.

In Mexico, the difference between the overnight (5.25 percent), and the 10-year and 30-year, was of 233 basis points and 320 basis points, better than the spread between those maturities in the United States.

In other words, although some factors, like those described here, widen the gap between short-term and long-term rates, there are factors that escape the scope of Banxico's monetary reach.

That is bad news, since bonds may be saying that as long as long-term rates in the United States remain high, credit for durable goods in Mexico may not return on a more permanent basis.

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