The turmoil in the US and European banking systems is testing even the most bullish cases of emerging markets.
The Mexican currency, which shocked Wall Street with a stunning rally last year, has suffered a sharp setback this month. Its 24-hour liquidity left it exposed to a quick sell-off of bets on the “superweight” when risk appetite among investors waned, and it has currently lost regarding 2.7% of its value once morest the US dollar since 3 March, when it hit a five-year high.
Before the banking problems arose, what had been the hardest-hit currency in the world at the start of the pandemic was boosted by an aggressive central bank, investments in the manufacturing sector amid the rebalancing of the global supply chain and surprisingly austere fiscal policy. Now, despite these positives, peso bulls see that the outlook depends on what happens north of the border.
The World Bank warns of a sharp slowdown in global expansion by 2030
“Once the dust settles, the weight should pick up,” said Marco Oviedo, Senior Fixed Income Strategist at XP Inc., the largest brokerage in Brazil. “The only real risk to the peso is some kind of Federal Reserve policy mistake or another shock to the global economy.”
In the past year, even despite falling in recent weeks, the peso has risen 9% once morest the US dollar, putting it second only to the Russian ruble in a Bloomberg basket of 23 of major emerging market currencies. The currency appreciated on Monday, while one-month implied volatility rose for the second day in a row.
Given the dollar’s own strength, the peso’s run looks even more impressive: measures of the real effective exchange rate of the Mexican currency, which compares it to a broad basket of currencies weighted by trade and adjusted for differences in Inflation levels rose in early March to the highest levels since 2014.
First Citizens buys Silicon Valley Bank following biggest bank failure since 2008
net shorts
But leveraged funds have quickly unloaded long currency positions in recent weeks, going net short for the first time in a year, according to the latest positioning data compiled by the Commodity Futures Trading Commission (CFTC). its acronym in English).
Of course it’s not just regarding weight. The turmoil in global financial markets has also impacted assets in developing countries, as traders have dumped riskier positions. Nervousness over global growth and interest rates spiked currency volatility, with the Mexican peso and Hungarian forint bearing the brunt.
One source of support for the peso has been the Bank of Mexico, which began raising interest rates in 2021 — nine months before the Federal Reserve — and raised them much higher, from 4% to 11%. He is expected to make another quarter-point hike at Thursday’s policy meeting, which would keep Mexico’s benchmark rate spread over the Fed at a record 625 basis points following the US central bank hike. last week.
Mexico’s economic activity exceeds all forecasts
But the risks looming for the US economy, in the form of banking problems, are suddenly looming, highlighting the critical importance of the US consumer to the prospects of many emerging markets. Those risks threaten to undermine another major force driving the peso: a rebalancing of world trade and manufacturing patterns amid the war in Ukraine and rising US-China tensions.
A growing number of companies are moving their production to Mexico to be closer to the US market, following widespread global supply chain disruptions in recent years. Tesla Inc. recently announced that it would invest in a new plant that Mexican authorities estimate will cost billions.
That trend may help underpin a structural shift in the peso’s relationship with the Chinese currency, reversing a 20-year slide once morest the yuan. But in the short term, the Mexican currency also depends in part on the strength of its exports, which would suffer in the event of an economic recession in the US Remittances and tourism would also be affected.
“So far, Mexico and the peso have benefited from the strength of the US economy, but that may change in the future,” said Carlos Capistrán, head of economics for Canada and Mexico at Bank of America.
tax hawk
One source of stability that will remain is that of President Andrés Manuel López Obrador. When he took office in 2018, investors originally viewed AMLO and his leftist platform as a big risk. Instead, it turned out to be a fiscal “hawk”, opting for a much more austere budget approach than many other countries, even in the worst period of the pandemic in 2020.
Now, with less than two years left in his term and many of the planned reforms already approved, investors do not foresee many more policy initiatives. That paves the way for the continuation of the status quo until a new president takes office at the end of 2024 and helps reinforce the bullish case for the peso.
“I’m not going to say that Mexico is risk-free, but compared to its peers, there are few immediate imbalances,” said Gabriela Soni, head of investment strategy at UBS Mexico. “Investors only start worrying regarding the election in the year it’s going to happen, so it won’t be something they start talking regarding until 2024.”
Brazil’s inflation cools for the tenth consecutive month
Meanwhile, the peso will likely continue to benefit when global investors are in a risk-on mood, and suffer when they are not. For now, that may be largely out of Mexico’s reach, until US and European regulators can assuage concerns regarding the state of banks in their jurisdictions.
“The Mexican foreign exchange market is competitive and almost perfect in terms of the flows that enter and leave freely, without central bank intervention. Those kinds of things make it look favorable,” said Gabriel Lozano, JPMorgan’s chief economist for Mexico and Central America.
“In general, I am optimistic regarding the recovery to some extent,” he said. “There can still be tough times, especially as we get closer to the end of the monetary policy cycle.”
You may also like
