​Wall Street bearish on super peso

Black Thursday

The Mexico peso has been up over 11% against the U.S. dollar year to date, making it the one of the best performing emerging currencies. That compared with the Indian rupee which was barely unchanged in the same period.

But it dropped 1.8% to 17.33 on Thursday after trading near an 8-year high earlier, on track to post its worst week in 20 months amid warnings from some analysts that the run-up is stretched.

JP Morgan strategists pared their bet on Mexican peso bonds Thursday due to the risk that U.S. Treasuries will rise even higher.

Strong bet on further peso gain added to its loss, said Shamaila Khan, head of emerging markets and Asia Pacific at UBS Asset Management Americas Inc.

‘The valuation of the currency did not make a lot of sense to us,’ she said. ‘That is now correcting with the market. It’s really the fact that it was a popular trade plus the valuations, which is why it’s underperforming today.’

Traders who borrowed the low-yielding yen to fund their peso bets are unwinding those positions after the BOJ surprised investors last week when it embarked on its ultra-loose monetary policy tweak.

Dubbed ‘super peso’ during its ascent, the currency is benefited from a confluence of higher interest rates, tight Fiscal Policy and the so-called nearshoring trend.

Super peso

Mexico’s central bank is even more hawkish than the Fed in monetary tightening. It began raising interest rates in June 2021, 9 months before the first rate hike announced in the U.S. after the pandemic.

The benchmark rate has grown from 4% to 11.25%, slowing Mexico’s headline inflation rate to 4.79% in the first half of July to its lowest level in more than two years.

With the Fed’s fund rate at 5.5%, the super peso still enjoys a significant yield spread even the Bank of Mexico chose to hold interest rates unchanged at its last two meetings.

President Andrés Manuel López Obrador’s fiscal austerity has also helped prop up the peso. The populist leader has slashed government spending and run small deficits.

During the pandemic, he resisted intense pressure to implement large support packages for businesses and individuals.

Mexico, located south of the States, has proved to be proved to be a prime beneficiary of multinationals diversifying their supply chain away from China.

It is part of the USMCA free trade agreement and was included in recent green subsidies under Washington’s Inflation Reduction Act.

Mexico's foreign direct investment rose 48% in the first quarter from a year earlier, surging to $18.6 billion, according to preliminary data Mexico's Economy Ministry released.

The country also replaced China to become the US’s largest trading partner during that period, with a total bilateral trade of $196.7 billion, up 8% year on year.

In March alone, goods from Mexico accounted for 16.1% of U.S. imports — beating out Canada (15.5%) and China (10.1%) — for a total of US $42.8 billion.

Compared with the same quarter a year earlier, the Mexican economy grew 3.7% in the second quarter, beating market expectation which stood at 3.4% according to a Reuters poll.

It expanded for the seventh quarter although at a slower pace, so whether the business activity will decelerate at a faster speed could play a vital role in what lies ahead for the super peso.

Kimberly Sperrfechter, emerging markets economist from Capital Economics, said ‘the economy will continue to slow over the coming quarters as the U.S. economy – Mexico’s largest trading partner – weighs on external-facing sectors while tight fiscal and monetary policy take their toll on domestic demand’.