FX FLASH update - MEXICAN PESO

Spot (mid-market) rate = MXN 20.1750/$ (10:45am, January 27^th, 2021)

Emerging Market Currency Performances in H2 2020

Mexican peso trades in a wide range

Last April, the USDMXN soared to 25.7850, the weakest-ever level for the Mexican peso against the US dollar. It quickly reversed, however, and the peso became the second best performing emerging market currency in the second half of 2020 (see table above). Last week, the peso strengthened further – the USDMXN falling to a 10-month low at 19.50 – only to bounce hard off that level and quickly rally to 20.25.¹ It’s currently trading near that level, and may swing within a 19.50-21.00 trading range over the medium-term. Over the long-term, however, we are bullish the MXN with a target of 18.50-18.75 within 12 months.

Mexico strives to contain Covid-19

All Latin American countries are battling major outbreaks of Covid-19 and its variants. A recent Reuters tally put Latin America as the region with the highest number of confirmed new cases globally. Mexico was named the country with the worst record for ‘number of vaccinations administered per 100,000 in population.² As of Monday, Mexico has recorded some 1.47 million cases and 129,987 deaths.³ Mexico’s President Andres Manuel Lopez Obrador revealed on Sunday that he contracted Covid-19.

Mexico’s economy is expected to grow 3.7% in 2021

Recent data showed unexpected improvement in Mexico’s economy, but most stats remain below pre-pandemic levels. According to a World Bank forecast, Mexico’s economy will recover from a 9% decline in 2020 and expand by 3.7% in 2021, with much of the growth in the second half.⁴ According to an IMF report, key challenges for Mexico include the pandemic, too much dependence on the US economy, high and rising crime, income inequality, weakening infrastructure and education, and decades of underinvestment in the oil sector.⁵

Mexico’s relatively high interest rates attract “carry trade” speculators

Mexico’s central bank [Banxico] rate of 4.25% is high compared to most other countries’ interest rates. Despite high volatility in the USDMXN (1M implied volatility = 15%), the attractive spread of short-term Mexican rates over US rates (up to 415 basis points) – and over Eurozone rates (up to 465 bps) – has compelled speculators to aggressively enter into “carry trades” by buying MXN & selling USD or EUR.⁶ Another rate cut of 25 bps is expected when Banxico meets February 11, but this should have little impact on the attractiveness of these carry trades. Bloomberg reported that foreign investors have been buying up Mexican debt (Moody’s give Mexico an “A” rating) at the fastest pace since 2016, and Mexico’s recent 50-year dollar-denominated bond was 3.33 times oversubscribed.⁷

Mexico resetting political relationship

Last Friday, President Joe Biden made a call to Mexico’s President Andrew Manuel Lopez Obrador, one of the first foreign leaders he called. According to sources briefed on the call, the conversation was friendly and non-confrontational (unlike the call with Putin), with the most contentious issues absent from the agenda. Mexico’s president said “We discussed issues related to migration, Covid-19 and cooperation for development and welfare,” adding “Everything indicates that relations will be good for the good of our people.”⁸ The US-Mexico-Canada (USMCA) trade deal signed in 2018 is unlikely to be revised.

Final comments:

• Last March, the global economic collapse triggered a flight-to-safety by investors into the US dollar and US Treasuries. Once again, the big central banks saved the markets by lowering rates and providing nearly unlimited amounts of liquidity. The subsequent “risk-on” mood which prevails today fueled demand for all types of ‘risky’ assets -- stocks, credit, commodities, foreign currencies and emerging market assets (stocks, bonds and currencies), including those of Mexico.

• Mexico is in a strong position to outperform other Latin American countries due to its relatively high interest rates, strong exports and close proximity to the largest consumer in the world (the US), and increasingly attractive supply chains as global trade “de-globalizes” away from China.

• We predict that the first quarter of 2021 will be a “transition period” for markets – bringing new uncertainties related to the Biden presidency, Covid-19 second/third waves and vaccine deployment, Brexit and rising US Treasury yields – which will lead to fairly wide swings in the currency markets, but provide good currency management opportunities. Nevertheless, we remain long-term US dollar bears / Mexican peso bulls.

Please feel free to reach out to your SVB foreign exchange advisor for a deeper discussion about the markets, what impact they may have on your firm, and ways to mitigate risk.