Mexico’s Economic Policy Hostage to US Volatility: Blame Trump and the Fed

October 18, 2016 2:00 PM

Poor Mexico.

The country may have lagged on some key reforms, but successive governments have consistently implemented the pro-growth, pro-business agenda touted by mainstream economists.

What do they have to show for it? A struggling economy that is still so dependent on the United States, itself experiencing its most anemic postwar recovery, that the Mexican central bank actually had to change the dates of its interest rate meetings so they could see the outcome of the Federal Reserve’s own policy actions before moving themselves. How deep is this dependence? Some 80 percent of its exports are destined for the United States.

The Mexican peso recently swooned to a record low as worries over possible US interest rate increases from the Federal Reserve were compounded by Republican presidential candidate Donald Trump’s vicious, often racist rhetoric against Mexico. Fears of his electoral prospects have directly affected the Mexican currency and stock markets. Trump has accused Mexico of intentionally driving “criminals” and “rapists” across the border, calling for the construction of a wall and renegotiation, and possibly revocation of the two-decade old North American Free Trade Agreement (NAFTA).

Given the disastrous impact that such policies would likely have on Mexico—not to mention the United States—it’s little wonder markets are nervous. Investors are even turning to one Mexico-focused exchange-traded fund to attempt to track the ups and downs of Trump’s fate in the polls. His decline following a subpar performance in the second presidential debate has helped stabilize Mexican markets.

The tumbling peso was likely part of the reason behind the central bank’s decision to raise interest rates further despite lingering economic weakness.

"The risk persists that volatility in domestic and international financial markets will intensify," the central bank said after its decision. "This is especially true if nervousness grows about the consequences of the U.S. electoral process, whose implications for Mexico could be particularly important."  

The concerns are all too real. According to an in-depth recent study from the Peterson Institute for International Economics, Trump’s trade agenda would be deeply damaging if enacted. Moreover, the extensive powers of the US executive provide little in the way of checks and balances to prevent him from unleashing a trade agreement wrecking ball.

Mexico’s central bank has already lowered its 2016 growth forecast four times, most recently to an estimate of 1.7 to 2.5 percent. Inflation has been below the official 3 percent target for 16 months.

Trump’s deteriorating prospect of winning the presidency following the release of tapes that revealed him bragging about sexual assault, and the subsequent emergence of several accusers saying he had assaulted them, have helped the peso rebound.

While US election-related volatility will be unavoidable until the November vote, the Federal Reserve’s role in stymying Mexican economic prospects is more of an unnecessary drag.

It’s not that Mexico has no role in its own economic misfortunes. The country suffers from chronic political deadlock, which has impeded the sort of energy sector and labor market reforms some economists argue could unleash faster growth and higher productivity.

At the same time, the Fed is an American institution with a domestic mandate. It is not, and should not try to be, the world’s central bank.

The problem is that Fed policymakers’ apparent keenness to raise interest rates is hard to explain given an inflation rate that remains consistently below the central bank’s target and which indicates the 5 percent unemployment rate grossly overstates the health of the US job market. And it so happens that the adverse reaction of this policy misguidance from the Fed is one thing that does trickle down—in this case, across the southern border.

As a major exporter of crude, oil is another, ever-present factor looming Mexico’s economy, and the long-run slump in prices has certainly hurt the country’s fortunes. Reducing that dependence, particularly with regard to the government’s budget revenue, must remain a long-term goal, though one that would certainly not be helped by the rising anti-trade sentiment permeating American politics.

Hopefully, the Mexican government’s recently announced $1 billion hedge on crude markets, which would price the commodity at $42 per barrel in 2017, can help brighten the outlook. That’s presuming crude markets keep cooperating.