Mexican peso rises amid steady risk appetite

• The Mexican peso eases higher on Thursday as global risk appetite supports emerging market currencies.
• The peso weakened on Wednesday after the Fed announced a 0.50% rate cut.
• USD/MXN is consolidating based on a rising channel and 50-day SMA.

The Mexican peso (MXN) edged higher in its most heavily traded pairs during the European session on Thursday as global equities rose amid an upbeat, broadly positive tone for emerging FX markets.

However, on Wednesday, the Peso lost ground following the US Federal Reserve’s (Fed) decision to cut interest rates by 0.50% at its meeting. MXN weakened by an average of 1.1% against the US Dollar (USD), Euro (EUR) and British Pound (GBP).

The Mexican peso probably wasn’t helped by comments from Victor Manuel Herrera, president of the National Economic Research Committee at the Instituto Mexicano de Ejecutivos de Finanzas (IMEF), on Wednesday. Herrera said the Mexican government’s controversial judicial reforms and the elimination of independent industry regulators could harm the Mexican economy by reducing its attractiveness to foreign investors, particularly from the US.

Mexican peso still overvalued – Capital Economics

The Mexican peso remains overpriced, according to London-based consultancy Capital Economics, and given the precarious state of public finances, is therefore poised for further declines in the future.

Well-publicized concerns about the leftist government’s radical constitutional reform plans aside, Mexico’s public finances are in bad shape and the country’s debt burden puts the economy at risk.

“President-elect Sheinbaum, current President Amlo’s protégé, will inherit a multitude of economic problems. In particular, the deterioration of public finances, which is exacerbated by the heavily indebted state oil firm Pemex, and could threaten Mexico’s investment-grade sovereign credit rating,” says Joe Maher, Assistant Economist at Capital Economics.

Another factor weighing on the peso is the cancellation of the so-called “carry trade”, where investors borrow in a currency where interest rates are low, such as the Japanese yen (JPY), and use the loan to buy a currency where interest rates are high, such as the Peso. As long as the Peso does not depreciate against the Yen, these investors will earn the difference between the loan interest repayments in Yen and the interest earned by being in Pesos. However, since the yen started appreciating on expectations that the Bank of Japan (BoJ) will raise interest rates, the carry has lost its luster.

Maher sees further negative pressure on the peso due to overvaluation based on purchasing price parity (PPP).

“The peso has room to weaken further. For example, it is still somewhat stronger than what is implied by the relative price levels in the US and Mexico,” says the Assistant Economist.

That said, the Mexican currency will gain some support from bullish risk appetite. Capital Economics’ base case is that the US economy will avoid a recession, and if this is true, the Peso should post gains.

“If we are correct in our belief that the US economy will avoid a recession, global risk appetite is likely to remain strong, which would support Mexican assets and the peso,” he adds.

However, Capital Economics is revising its forecasts downward, expecting the peso to weaken to USD/MXN 20.00 by the end of 2024 and 21.00 by the end of 2025.

Technical Analysis: USD/MXN is consolidating near the bottom of the channel

USD/MXN is consolidating near the bottom of a long-term rising channel.

The pair declined last week after forming a Japanese Three Black Crows candlestick pattern (shaded rectangle in the chart below). The model indicates prices could fall further in the near term. However, key support at the base of the channel and the 50-day simple moving average at 19.02 stand in the way.

USD/MXN Daily Chart

USD/MXN could slightly extend the weakness to the lower channel line around 19.01 and the nearby 50 SMA. Despite being in a near-term downtrend, these firm support levels will be difficult for the bears to break. There is a risk that USD/MXN will simply stabilize and use the support shelf to launch a recovery within the channel, thus extending the medium to long-term uptrends.

A decisive break below the lower channel line and 50 SMA would be needed to change the outlook and indicate a continuation of the downward move.

A decisive break would be one accompanied by a long red candle that breaks well below the channel line and closed near the low, or a three-day bottom in a row that broke clearly below the line.