Main Talking Points:
- The Mexican Peso stood out as the best performing emerging market currency in 2019
- Fundamentals do not support this growth further into 2020
- USD/MXN reverses its downward trend and corrects some of its losses
There is no doubt the Mexican Peso has been the outstanding emerging markets currency in the last few months, appreciating 5% since the end of November against the US dollar alone. If we look at its performance against the Euro, it’s continued strength coupled with euro weakness has seen EUR/MXN hit lows last seen July 2017.
What is Behind this Recent Strength in the Mexican Currency?
Well if you look at solid economic data, the Mexican economy hasn’t been performing well. Data for the last two months has shown that inflation is stagnating, retail sales are falling and economy activity is slowing. But like most emerging market currencies, the Mexican Peso enjoys a push when risk appetite is at a high.
The effect of this risk-driven demand is evident if we look at the performance of USD/MXN in recent days, when an outbreak of coronavirus spooked investors and money fled from risky assets towards risk havens like gold and the US dollar. As the risks of the virus spreading became an increasing worry across the world at the beginning of this week, USD/MXN halted its decline and has manage to recover 1% of its value, after rallying as much as 1.72% when measured at the height of the risk-aversion sentiment on Monday.
But before the world was concerned about a world virus outbreak, markets were enjoying some much needed calm after ongoing trade wars between China and the US, Brexit concerns, and a spike in geopolitical tensions in the Middle East kept markets highly volatile throughout most of 2019. This period of market stability allowed riskier assests like the Mexican Peso to gain some ground, but it’s recent strength has also been influenced by a series of fundamental factors:
3 Key Factors that have Boosted the Mexican Peso:
- The end to US-China trade wars: as I mentioned above, the signing of a phase one of the long-awaited trade deal meant that market apetite for riskier assests increased, which also improved investor sentiment regarding global growth and financial stability.
- The approval of CUSMA: this new trade deal, which stands for Canada-USD-Mexico trade agreement, replaces the old North American Free Trade Agreement (NAFTA) which was blamed by Donald Trump for hindering the US manufactoring sector. The ratification of the agreement means that Mexico’s economy will receive a much needed boost after a period of uncertainty about the future of its trade relationship with the northern american countries, especially given a period of stagnant domestic growth.
- Carry Trade value: with an interest rate at 7.25%, the Mexican Peso enjoys the benefit of the “carry trade” strategy, where investors borrow money from lower-yielding currencies to buy bonds and financial assets of higher-yielding currencies. These means that there is a flow of capital from the US or European currencies towards Mexico, especially given that most developed economies are going through a period of unprecedented low interest rates. A carry trade from the euro to the Mexican Peso would now yield a diferential of 7.75%, given that the euro lending rate is currently -0.5%.
Mexican Peso Outlook
Despite its stellar performance since the end of 2019, the long-term outlook for the Mexican Peso is neutral to dovish, given its lack of long-term sustainability. In the shorter-term, demand is likely to be driven by risk events, with focus on the development of the coronavirus and its effect on US dollar safehaven demand.
As mentioned before, the economic data for Mexico is not particularly great and given its softening inflation, Banxico, Mexico’s Central Bank, will likely need to cut rates further in 2020, which will diminish the currency’s carry trade diferential, one of its most sought after traits. On top of that, the central bank mentioned at its lastest policy meeting that economic activity is weakening and growth remains stagnant, putting further pressure on the Mexican Peso. Special focus on CPI and GDP data to be released in the following weeks to gauge the Central Bank’s future stance on monetary policy.
It is also important to remember that demand driven by risk appetite is volatile and not sustainable in the long-term, especially when it is not supported by fundametals and economic data. Therefore, we may see Mexican Peso weakness continuing in the short-term.
USD/MXN Daily chart (2017-2020)
If we look at a USD/MXN daily chart we can see that the symetrical triangle that had been in play since the beginning of 2017 was broken to the downside at the beginning of December 2019, which consolidated the downward trend. The price then bounced off a key support zone, located between 18.73, key support in April 2019, and 18.49, key support in September 2018.
On the upside, USD/MXN could find key resistance at 19.10 where the 100-DMA is located. Beyond that, resistence is likely to appear at th 50% Fibonacci retracement from 2018 highs, at 19.21, which served as a key support are in June 2019.
— Written by Daniela Sabin Hathorn, Junior Analyst
Follow Daniela on Twitter @HathornSabin