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Another Country Considering A Rate Cut And It May Need More Than One

ETF Professor

The iShares MSCI Mexico ETF (NYSE: EWW) is up just 2.65% year to date, well below the returns of the MSCI Emerging Markets Index and the S&P 500. Slumping Mexican stocks could be a sign Latin America's second-largest economy needs some jump-starting.

What Happened

As has been noted, stocks in Mexico are scuffling and some global monetary groups are reducing economic growth forecasts there. President Andres Manuel Lopez Obrador, often referred to as AMLO, believes his country's benchmark lending rate of 8.25% is too high for an economy that's stuck in neutral. He may be right because 8.25% is high relative to some other larger developing economies.

While AMLO's view on interest rates is not as overt as his northern counterpart, President Donald Trump, there is a case for lowering rates in Mexico because inflation there is relatively low.

“Mexico’s central bank has kept its benchmark rate at a decade-high 8.25%, even as inflation eased to below 4%,” according to Bloomberg. “The result is one of the world’s highest real interest rates -- helping to make the peso among the strongest currencies this year.”

Why It's Important

A strong peso is problematic for Mexico because the economy is export-driven. Sales in weaker foreign currencies have to be converted into stronger pesos, meaning crimped profits. Additionally, the sector composition of EWW is rate-sensitive.

The $688 million ETF, which tracks the MSCI Mexico IMI 25/50 Index, allocates over half its weight to the consumer staples and communication services sectors. The latter is still more traditional telecom in Mexico, indicating this fund is heavily exposed to sectors with bond like properties that would likely benefit from lower interest rates.

“Two of the five members of the central bank’s rate-setting board have suggested that there’s room for easing, but the majority view has been that core inflation remains too high,” according to Bloomberg.

What's Next

Interest rate swaps indicate Mexico's central bank is poised to cut rates by a modest 25 basis points sometime over the next 90 days. That's a start, assuming it even happens, but at 8.25%, there is ample room for rates to fall further in Mexico, indicating that a reduction of just 0.25% may not be enough to renew global investors' interest in Mexican stocks.

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