Thoughts

November 04, 2022 | 14:05

Can Mexico Escape a U.S. Recession?

Economist

Senior Economist and Vice President
Economics

Sarah Howcroft conducts risk analysis across a range of countries and industries in which BMO has strategic inte... (Read more)

Sarah Howcroft , CFA

Senior Economist and Vice President
Economics

Sarah Howcroft conducts risk analysis across a range of countries and industries in which BMO has strategic inte... (Read more)

Mexico’s economy handily surpassed expectations in the third quarter, posting real GDP growth of 4.1% q/q annualized. Even with an expected slowdown in the fourth quarter, we are now looking for growth of around 2.7% in 2022 as a whole (vs. 4.8% in 2021). This would mark a relatively robust performance given soaring food and energy prices (recall, Mexico is now a net oil importer) and associated monetary tightening. Questions have now shifted to the outlook for 2023—specifically, can Mexico resist a widely anticipated, albeit likely moderate, recession in the U.S. economy?

The importance of Mexico’s northern neighbour is hard to overstate. The U.S. accounts for a little over 80% of merchandise exports, 65% of tourist arrivals (by air) and a whopping 95% of foreign worker remittances. And, these shares are up slightly from pre-COVID levels, highlighting the significance of the stimulus-fuelled U.S. recovery as a driver in Mexico’s own post-pandemic rebound. Clearly, a downturn in the U.S. will have implications for these inflows, especially with interest rates still ratcheting higher. If we look back to the Global Financial Crisis, Mexico’s total remittances dropped by roughly 20% and exports by 25%, with the ultimate effect being a recession of twice the magnitude versus that seen stateside. Should we expect to see a similar situation play out over the next year? We tend to think not.

For one thing, although we are below consensus forecasts for U.S. GDP in 2023 (at 0.0% vs. 0.4% in the current Bloomberg poll), we aren’t anticipating a correction anywhere near as deep as during the GFC. Of course, consumers on both sides of the border will have to contend with a protracted period of above-target inflation and elevated interest rates. In Mexico’s case, the central bank has already cranked up the policy rate by 525 bps since June 2021 to a record 9.25%. Another 100 bps (give or take 25 bps) should bring the rate to its terminal point in the coming months followed by a shift to gradual easing in the latter part of 2023. Although inflation—especially core inflation, which edged up to 8.4% y/y in mid-October—is proving sticky, the peso’s continued resilience against the mighty greenback seems to indicate that Banxico is well on its way to re-establishing price stability.

Perhaps the most significant source of support for Mexico at present is the enduring strength of the U.S. labour market, which continues to fuel money transfers by migrant workers. Interestingly, the surge in remittances during the pandemic was more a factor of greater average remittance amounts than an increase in the number of transactions. Moreover, many migrants are employed in service sectors, which have seen above-average earnings growth and, up until recently, faster employment gains. All told, notwithstanding the back-to-back quarterly U.S. GDP declines in H1/22 and sharp decline in confidence levels, there has been little impact thus far on remittances or tourism receipts, with both currently at record highs. In fact, Mexico recently surpassed China as the world’s second-largest remittance recipient after India, with these transfers now amounting to over 4% of GDP (up from 2% a decade ago).

Bottom Line: We think the Mexican economy will avoid an outright contraction in real GDP next year thanks to strong remittances and tourism, which are providing a valuable buffer to households and businesses in the face of mounting inflation and global economic headwinds. Accordingly, barring a deep U.S. recession, we are projecting real GDP to expand by 1.0% in 2023.