We discuss the ex-post effects of Banxico’s surprise 50 bp hike as a response to MXN weakness on Mexico’s local rates market.

　　Among other factors, hedging demand stemming from the high percentage of foreign ownership in MBONOs has contributed to the increased underperformance of the MXN in bouts of USD strength.

　　We believe that Banxico’s policy response to MXN weakness last February has fueled the impression of monetary policy subordination (to FX) and increased the sensitivity of TIIE (level , slope and spreads to the US) to the MXN and global risk factors.

　　At odds with the accommodative fundamentals, expectations of pre-emptive rate hikes to curb the peso depreciation have driven the embedded monetary policy premium in TIIE to extremes, with front end spreads vs the US trading at the top of the range.

　　The same applies to the long end where credit took the back sit as a risk driver. We show that FX subordination has been responsible for the widening in spreads vs the US and the recent bear-flattening in TIIE.

　　We believe that both the embedded premium in TIIE - front end and long end (vs US) - as well as the flatness of the curve are exacerbated and mostly driven by USD strength.

　　Capturing the premium however is predicated on Banxico “de-coupling” its monetary policy from FX. The higher odds of a recession have increased, in our view, the likelihood of such and the search of alternative mechanisms to offer USD hedges.