Mexican peso trades lower as geopolitical concerns weigh

• The Mexican peso is trading lower in key pairs due to risk aversion from escalating conflict in the Middle East.
• Carry-trade exits on the back of a strengthening yen remain headwinds.
• Technically, USD/MXN is pulling back into a rising channel.

The Mexican peso (MXN) is trading about half a percent lower in its most traded pairs on Monday morning as traders return to their desks after the weekend break.

Fears of an escalation in the Middle East after a bloody exchange between Israel and Hezbollah are weighing on riskier assets, including the MXN, and the continued appreciation of the Japanese yen (JPY) suggests more exits from commercial shipping, of which the Peso. was a key beneficiary.

Mexican peso benefits from Fed Powell’s Jackson Hole speech

The Mexican peso experienced a temporary rebound on Friday, triggered by a speech by Federal Reserve (Fed) Chairman Jerome Powell at the banking symposium in Jackson Hole, where he confirmed that the Fed will cut interest rates. Powell said a noted slowdown in the US labor market was a key reason for the reduction in borrowing costs.

“The timing and pace of interest rate cuts will depend on incoming data,” Powell said, adding that “upside risks to inflation have diminished, downside risks to employment have increased.”

His comments sent the US dollar (USD) lower in the pair as the expectation of lower interest rates is negative for a currency as it usually leads to a drop in foreign capital inflows. USD/MXN ended the day down over two percent. EUR/MXN and GBP/MXN also fell, but to a lesser extent.

After Powell’s speech, other Fed officials chimed in with similar views. Chicago Fed President Austan Goolsbee said attention needs to be paid to the cooling labor market as inflation is now on a sustainably lower path in an interview with Bloomberg News. Patrick Harker of the Philadelphia Fed said the Fed needs to be methodical in its approach to cutting interest rates, perhaps cautioning against any big rate cuts.

Overall, the Mexican peso is in a downtrend and despite Friday’s recovery, it ended the week substantially weaker in its key pairs. A combination of factors, including lower-than-expected Mexican inflation data for August, weaker retail sales in July and resurgent concerns about the impact of the new government’s proposed changes to the Mexican constitution, were seen as factors influencing currency.

The carry trade evacuates a headwind

The carry trade – which has benefited the Peso with high foreign capital inflows for several years – is unwinding, adding another fundamental negative factor for the MXN. The trade involves traders borrowing in a currency where interest rates are low – such as the Japanese yen (JPY) – to purchase a currency where interest rates are high – such as the peso.

Assuming no change in the exchange rate, traders pocket the difference between the interest they have to pay on the loan and the interest they earn on the investment. However, with the Japanese yen (JPY) now rising and the Mexican peso lower, commercial shipping is not as profitable as before and this is causing MXN exits.

Part of the reason for the peso’s popularity in the shipping trade is Mexico’s relatively high interest rates. These, which are set by Banco de Mexico (Banxico), peaked at 11.25% in 2023. However, the bank has since cut them to 10.75% in two 0.25% cuts.

In August, Banxico surprised the markets by cutting rates by 0.25%. The release of the minutes of Banxico’s August meeting last week, however, show that the decision was only narrowly agreed, with two of Banxico’s five-person board voting against a cut. This suggests that further rate cuts may be delayed or implemented at a more relaxed pace – a mildly supportive counter factor for the MXN.

At the time of writing, the US dollar (USD) buys 19.23 Mexican pesos, EUR/MXN trades at 21.52 and GBP/MXN at 25.40.

Technical Analysis: USD/MXN pulls back into rising channel

USD/MXN is in a broad uptrend in a rising channel that generally favors longs over shorts.

After Friday’s decline, however, the short-term trend is unclear and despite the overall bullish technical position, there is a risk of more weakness, possibly a return to the lower channel line around 18.55. A break below 19.00 would confirm several downsides.

USD/MXN Daily Chart

That said, the overall trend over the medium to long term time frames is likely to be rising, suggesting an optimistic backdrop. This could easily trigger a quick recovery and continuation of the up leg seen since August 19, towards a target at the channel highs around 20.50.

A break above the August 22 high of 19.53 would provide further confirmation of the continuation of the upward leg.