Spot (mid-market) rate = MXN 18.90 / USD (12:00pm, July 9th, 2019)
One year ago on July 1, 2018, Andres Manuel Lopez Obrador won Mexico's presidential election. The veteran leftist politician presented himself as an agent of change and secured a landslide win. Since then, the Mexican peso has become the strongest currency in the world (Table 1). As of today, it’s kept its place on top of the leader board for July (Table 2).
- The US-Mexico trade deal went better-than-expected. Businesses on both sides of the border are relieved that President Trump backed off from a stepped-up trade war with Mexico, but his tariff threat still looms large.
- Global investors show confidence in President Obrador. Demand for Mexican stocks and bonds increased significantly following President Obrador’s election and this has continued. Remarkably, the MSCI Emerging Market Latin American (equity) Index outperformed all other EM regional indices around the world.
- Mexico’s interest rates remain attractive. Both long- and short-term rates declined this year, but remain attractive compared to those of other developing economies. In fact, the long MXN/short USD currency pair is the best performing (short-term) “carry trade” in 2019 of all currency pairs. The highly profitable MXN/USD carry trade may be the single most important reason for the peso’s strength.
- Debt rating downgrades. There is a cause for concern here, especially for creditors. Ratings agency Fitch recently downgraded Mexico’s debt rating, citing risks posed by heavily indebted oil company Pemex and trade tensions. Moody’s has lowered its outlook to Negative.
- Economic uncertainty prevails. Many recent indicators are pointing to a weakening Mexican economy. The IMF recently cut Mexico’s GDP growth forecast from 2 to 1.6 percent, citing declining private investment and government spending as negatively impacting its economic growth.
Here is a weekly chart of movements in the USD/MXN. We can see that the trading range over the last two years has been narrowing. Our view is that the currency pair will break below the supporting uptrend line and head towards a MXN 17-18 range. Within that new range lies the 50% retracement of the entire upmove from 12.85 to 21.60, and where previous key tops and bottoms also reside. The timing is uncertain, we estimate within 3-9 months.
We are bullish the Mexican peso. However, further strength in the peso may be constrained by political uncertainty with Mexico’s new administration and by a slowing economy. We expect Mexico’s central bank to begin an easing cycle later in the year.
Mexico remains vulnerable to hiccups in US-Mexico trade relations. Yet Mexico has been a major beneficiary of the ongoing US-China trade war – in fact, Mexico now tops China as the biggest exporter to the US.
This signals a radical change in global trade: the US-China trade war is fueling the transformation of global trade, towards a “de-globalization” of supply chains. Cheap labor is no longer the dominant driver of production. Consumer demand for popular items such as clothing and electronics, along with the rise of highly customized products, is forcing manufacturers to locate production closer to their consumer markets. Mexico is right next door to the largest group of consumers in the world – the good ol’ USA, which makes us bullish Mexico and the Mexican peso.
Tactical hedging of MXN-denominated expenses is recommended if the USD/MXN climbs to 19.25-19.50 . Strategic hedging should be considered, as our longer-term view (1-3 years) is for a stronger Mexican peso and a weaker US dollar against all currencies.