Disappointing U.S. Retain Sales Did to MXN What S&P Failed to Do

The Mexican peso is under pressure following the disappointing US retail sales. The US dollar is at its best level against the peso since May 4th when the anxiety over the swine flu broke. The central bank meets at the end of the of the week and a large rate cut is likely.

The overnight rate in Mexico is currently at 6%. The Bloomberg and Dow Jones surveys find most expect a 75 bp rate cut. The yield on the benchmark 28 day cetes fell 18 bp at yesterday's auction to 5.36%, suggesting the cut is largely discounted.

The current easing cycle began in January and through last month the central bank had cut 225 bp. It was slow at first as the peso was weak and the pass through to inflation was strong. April inflation stood at 6.17% up from 6.04% at the end of March. Core inflation, which excludes energy and fresh produce prices, is still stubbornly high at 5.81% in April (5.83% in March).

Still the central bank seems to expect that inflation may have peaked and this suggests that is the consensus is off, it is that the central bank is more aggressive and cuts by 100 bp. The economic consequences of the swine flu and the policy response will aggravate the headwinds.

At current levels near MXN13.35, the dollar is a little more than 14% below its peak set near MXN15.59 in early March. The dollar has build a base near MXN13.00 and today firmed to near MXN13.40, a key technical area. A break of this area is needed to signal another 1.5%-2.0% advance. That said, it appears that area will hold and that the dollar can setback toward MXN13.15-MXN13.20.