Mexico's inflation outlook seems more complicated

USD/MXN has reached our target and may remain near current levels on Fed lift-off uncertainty. The fiscal policy is believed to remain a wild card because oil prices have significantly undershot the USD79bbl level earmarked in the 2015 Budget. For the 2016 budget, the oil hedge will stand at USD49bbl. 

"The government does hedge oil revenues, we estimate that these hedges only cover about 60% of the projected oil income. The nominal budget deficit is expected to reach 6% of GDP assuming USD30bbl and 5% of GDP assuming oil prices at USD50bbl. Part of the fiscal imbalance might be compensated by higher tax revenues", states RBC Capital Markets. 

The government has raised a transaction tax on credit cards. This, in addition to tighter supervision may help make up for some of the oil revenue shortfall. In all, fiscal balance is running at a 50% pace higher over the same period in 2014.

The inflation outlook will become more complicated following 25% peso depreciation over the past year. Nevertheless, base effects and currency weakness may raise inflation to 3.5% in January 2016 from 2.9% now. 

In July, Banxico changed its MPC meeting schedule to match that of the FOMC. The market sees this as a strong hint that Banxico may opt to tiptoe behind Fed hikes. This may not be enough to maintain currency stability despite USD 200mn daily selling and an additional USD200mn during business days of 1%depreciation, added RBC Capital Markets.