A possible dissonance between what happens in reality and the caution of the FED could generate market decisions that, independently of the monetary authority, will push up revenues.
Inflation in the United States, measured by the consumer price index, reached 6.2 percent at an annual rate in October. It was the highest number in nearly 31 years.
Curiously, inflation in Mexico that month was also the same figure, something unprecedented, because usually in our country the price increases were higher than those that occurred in the United States.
One of the most intense and important debates today is the nature and prospects of inflation. Some think that it is a transitory process that is going to give way soon, and that it is, above all, the product of an economic imbalance after the pandemic, but that it will be corrected in the following months.
For example, the United States Federal Reserve considers it that way. And for that reason it has not used the rise in interest rates as a mechanism to try to stop the increase in prices.
In fact, for the Fed, the relevant index is not consumer prices but consumer spending, the most recent reading of which indicates a rise of 4.4 percent, less than the index that usually measures inflation. What’s more, if food and energy, which tend to fluctuate widely, are excluded, the figure is 3.6 percent, just over half of what the most popular index for measuring inflation records.
In other words, this index is something like what we call core inflation in Mexico, and it is the one that the FED considers relevant. So a 3.6 percent level has not yet raised the alarm bells. For this reason, its handling of rate policy has been very cautious.
Others, however, think that the FED is wrong and that, as a result of the injections of money for 120 billion dollars a month, to face the crisis that came with the pandemic, we have an inflationary pressure that is far from being temporary.
The consequence of the difference in diagnosis is relevant. If the second interpretation prevails in the market, then many investors will assume that the Federal Reserve is going to raise its benchmark rates earlier than it has said, and for the same reason, they will create pressure on interest rates that could generate capital movements. which in turn would hit emerging market currencies, like our peso.
For the monetary policy implemented by the Fed to be effective, it is crucial that it maintains its credibility. For that reason, it was important for President Biden to define who would be in charge of the Federal Reserve, so on November 22, he made the decision to ratify Jerome Powell in his position. The vision of the President of the United States is that it is better and safer to stick with the current FED directive.
To the extent that investors perceive that the Open Market Committee meetings in which monetary policy is decided are making decisions with well-founded and true information, they may not challenge a monetary authority, which is no longer subject to possible changes.
But, regardless of who is in charge of the central bank, if they perceive that there is dissonance between what is happening in reality and what the Fed is proposing, then it would be more feasible for them to make market decisions than, regardless of the monetary authority, they will push up revenues.
It already happened recently in Australia and it would not be impossible that it could happen in the United States.
In Ben Bernanke’s time, early in the last decade, ambiguous signals from the Federal Reserve produced abrupt capital movements that created financial instability on an international scale.
The implications of such an event would be serious for countries like Mexico. In our country we have not reached inflationary levels that are unprecedented in 31 years, as in the United States, but if inflation in November, as Deputy Governor Jonathan Heath anticipated, reaches 7 percent, it will be the highest since April 2001 .
Between 2000 and 2020, inflation in Mexico ranged mostly from 3 to 6 percent, so clearly the current situation implies higher levels than we have observed in two decades.
In a scenario in which there is a large capital movement, we would surely have an abrupt depreciation of our currency and it would be very difficult to avoid a greater inflationary impact.
Towards the third week of November we already saw a dollar of 21 pesos again, so there is already expectation and nervousness. However, the levels of inflation that have occurred in Mexico in recent years are far from being the highest in our recent history, as in the case of the United States.
The last major inflationary eruption occurred alongside the crisis that erupted after the 1994 devaluation, when in December 1995 inflation reached 52 percent. But even then the worst circumstance in our history did not appear. This occurred as a consequence of a series of macrodevaluations that triggered the price of our currency against the dollar more than 4 times between 1985 and 1986. Inflation soared and reached a maximum of 180 percent per year in the first months of 1988.
We are far from being at risk of having a crisis like the one that occurred then and that required the heterodox solution of freezing prices and wages to anchor inflation expectations, but the eruption of a situation of financial instability on a global scale could severely affect the economy of our country.
A macrodevaluation has seismic effects on the price formation process and leads to expectations feeding the inflationary process. That is why it is so relevant for Mexico that the bulk of investors do not bet against the Federal Reserve and even more so that they do not win on that bet.
Although the level of Mexico’s public debt is lower than that existing in other economies and that reduces the vulnerability of our finances, in any case, it is high enough to turn a currency crisis into a fiscal crisis as well, due to the percentage of liabilities in foreign currency held, both by the federal government and by Pemex.
So the evolution of the financial situation of the United States will have to be carefully considered, as it will affect us directly.