- The Mexican peso has outperformed all other Latin American currencies (vs. USD) since early April.
- Mexico's high interest rates are attracting "carry trade" speculators.
- The peso should continue to benefit from the dollar's downtrend and Mexico's relatively high interest rates, strong exports, and positioning as global supply chains shift.
Mexican Peso (MXN)
Spot (mid-market) rate = MXN 22.3310 / USD (2:30pm, August 12th, 2020)
On April 6, the Mexican peso weakened to 25.7850, its weakest ever against the US dollar. Since then, the Mexican peso has had a turnaround, outperforming all other Latin American currencies.
Spot Returns (%) since April 6th, 2020: Latin American currencies
The current themes driving the value of the MXN are:
Mexico struggling to contain Covid-19. All Latin American countries are battling major outbreaks of Covid-19. A recent Reuters tally put Latin America as the region with the highest number of confirmed cases globally. In Q2, Mexico’s economy contracted by 17.3%, its fifth straight and worst-ever quarterly decline.
Mexico’s high interest rates attract “carry trade” speculators. Mexico’s central bank rate of 5.0% compares favorably to other Latin American interest rates and the U.S. Fed’s target rate range of 0% - 0.25%. Despite relatively high volatility in the USDMXN (1M implied vol = 15%), the interest rate spread (up to 475 basis points) has motivated speculators to enter into “carry trades” -- selling USD / buying MXN. Another rate cut of 50 bps is expected when the Central Bank of Mexico meets tomorrow, based on expectations of continued low inflation and a weakening Mexican economy.
Global investors are in risk-on mode. Since the financial crisis in 2008/2009, large central banks have pumped and continue to pump trillions of dollars’ worth of liquidity into the financial markets. Alongside, they created insatiable demand for all global financial assets – pulling prices higher in developed and developing markets. Investments in Mexican assets have shown outstanding risk-adjusted returns, a trend which analysts expect to continue. Bloomberg reports that foreign investors have been buying up Mexican debt (Moody’s give Mexico an “A” rating) at the fastest pace since 2016.
US dollar shows seasonal strength in August. Despite our long-term view of a weakening dollar, August is traditionally a month when the dollar is strong. Large currency speculators are currently positioned short US dollars, in the largest size since 2018, making a short squeeze increasingly likely. We believe any seasonality-related jumps in the dollar should be looked upon as an opportunity to sell dollars / buy Mexican pesos.
High trade vs low productivity. Today, Mexico exports more manufactured goods than the rest of Latin America combined. To attract global investors over the long term, however, Mexico must show progress on domestic issues. Its outdated and dysfunctional labor, tax, and social insurance regulations, weak contract enforcement, corruption and violence contribute to low productivity, pulling the economy lower. It remains to be seen how the recent United States-Mexico-Canada Agreement (USMCA) will benefit all three countries.
Our view is that the US dollar in the early stages of a secular downtrend, which will push all foreign currencies higher, including the MXN. Today, Mexico is in a good position to outperform other Latin American countries due to its relatively high interests, strong exports, and increasingly attractive as supply chains “deglobalize” (highlighted in my Jan-21st MXN update). Nevertheless, any changes benefiting the peso may be tempered by failing domestic issues, leading to lower productivity and a weaker economy.
Tactical hedging of MXN-denominated expenses is recommended if the USD/MXN climbs back up into the 23.00-24.00 range. Strategic hedging should also be considered, as our longer-term view (1-3 years) is for a weaker dollar/stronger Mexican peso.
Please feel free to reach out to your SVB Currency Advisor for a deeper discussion about FX, what impact it may have on your firm, and ways to mitigate risk.
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