Mexican peso recovers as risk appetite improves, carry-trade flows remain supportive

VaselineAugust 29, 2024

0 4 minutes read

Mexican peso recovers as risk appetite improves, carry-trade flows remain supportive

The Mexican peso is trading slightly higher as risk appetite improves on Thursday.
Disappointing Nvidia earnings weighed on stock markets during the Asian session, but they are recovering.
Mexico’s high interest rates continue to attract carry-trade flows despite the peso’s weakness.

The Mexican peso (MXN) is trading higher in its key pairs on Thursday as market sentiment improves ahead of the European session, benefiting MXN risk. European shares are trading modestly higher after a shaky start as investors get over the bitter taste of Nvidia’s disappointing earnings.

The Mexican peso rose the most against the euro (EUR) after preliminary Spanish consumer price index (CPI) data for August revealed a sharper-than-expected slowdown in inflation in Spain, one of the member states with higher levels of inflation in the euro area. Several key German states also released inflation data ahead of the German-wide release later today, signaling that price pressures are also easing in the eurozone’s biggest economy.

The data suggests that the European Central Bank (ECB) will continue to cut interest rates, which is negative for the euro as it would reduce foreign capital inflows.

At the time of writing, one US dollar (USD) buys 19.59 Mexican pesos, EUR/MXN trades at 21.73 and GBP/MXN at 25.84.

Mexican peso up, limited by political risk

The Mexican peso may see upside potential limited by political risk factors. The government’s proposed reform to elect judges and magistrates by popular vote has been criticized as undermining justice, democracy and investor confidence in Mexico.

Disagreement over the reforms led to public demonstrations in Mexico City by members of the judiciary. The US ambassador to Mexico, Ken Salazar, said that “the direct popular election of judges is a major risk to the functioning of democracy in Mexico.”

The Mexican government on Tuesday chose to “suspend” diplomatic relations with both the US and Canada over disagreements over reforms. If the impasse intensifies, there is a chance it could negatively impact free trade between the three countries, with negative implications for the Mexican peso.

At the same time, the Peso could benefit from an escalating trade war between North America and China. News on Tuesday revealed that Canada has decided to raise tariffs on Chinese electric vehicle (EV) and steel imports by 100% and 25% respectively.

However, the decision could benefit Mexico because of its existing role as an intermediary producer for Chinese goods entering North America.

Mexican peso recovers from interest rate differentials

The peso is further supported by the high level of interest rates set by the Bank of Mexico (Banxico) at 10.75% compared to peers. The spread between interest rates has gained particular importance as expectations increase that the Federal Reserve (US) will make deep cuts in US interest rates.

According to data from the Chicago Board of Exchange (CBOT), for example, the market is pricing in 1.00% of Fed tapering before the end of the year. This would see the main food funds rate drop from 5.25%-5.50% to 4.25%-4.50%, further widening the gap with Mexico. That said, Banxico is also expected to cut interest rates, although according to consultancy Capital Economics, not as strongly as the Fed (0.50% by the end of the year instead of 1.00%).

Overall, the spread continues to favor foreign capital inflows into the Peso, although the recent weakness of the Peso has reduced the popularity of the MXN carry.

Technical Analysis: USD/MXN

USD/MXN pulls back as it moves higher in a rising channel. It’s in an established upward trend, with “trend being your friend” favoring long pants over shorts.

USD/MXN 4 Hour Chart

Lately, the pair has pulled back to support around 19.52 (August 22 high) and is trading in the 19.50s. However, given the dominant uptrend, the odds favor an eventual recovery and higher resumption.

A break above 19.80 would confirm more gains towards the upper channel line in the 20.60s.

Frequently asked questions about the Mexican peso

The Mexican peso (MXN) is the most traded currency among its Latin American peers. Its value is largely determined by the performance of the Mexican economy, the policy of the country’s central bank, the volume of foreign investment in the country, and even the level of remittances sent by Mexicans living abroad, especially in the United States. Geopolitical trends can also move the MXN: for example, nearshoring – or the decision by some firms to relocate production capacity and supply chains closer to their home countries – is also seen as a catalyst for the currency Mexican, as the country is considered a key manufacturing hub on the American continent. Another catalyst for the MXN is oil prices, as Mexico is a key exporter of the commodity.

The main objective of Mexico’s central bank, also known as Banxico, is to keep inflation at low and stable levels (at or near its 3% target, the midpoint in a tolerance band of 2% to 4% ). For this purpose, the bank sets an appropriate level of interest rates. When inflation is too high, Banxico will try to tame it by raising interest rates, making it more expensive for households and businesses to borrow money, thus reducing demand and the overall economy. Higher interest rates are generally positive for the Mexican peso (MXN) as they lead to higher yields, making the country a more attractive place for investors. Conversely, lower interest rates tend to weaken the MXN.

Macroeconomic data is essential to assess the state of the economy and can impact the valuation of the Mexican peso (MXN). A strong Mexican economy based on high economic growth, low unemployment and high confidence is good for the MXN. Not only does it attract more foreign investment, it can encourage the Bank of Mexico (Banxico) to raise interest rates, especially if this force is associated with increased inflation. However, if economic data is weak, the MXN is likely to depreciate.

As an emerging market currency, the Mexican peso (MXN) tends to struggle during periods of risk, or when investors perceive broader market risks to be low and are therefore willing to commit to investments that carry more risk. great. Conversely, MXN tends to weaken during periods of market turbulence or economic uncertainty as investors tend to sell riskier assets and flee to more stable safe havens.

VaselineAugust 29, 2024

0 4 minutes read