Don't Panic: Mexican Peso Correction Following Banxico's Move to Unwind Dollar Position
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Mexican peso corrects: Don't panic!
USD/MXN has spiked higher on news that Banxico wants to start unwinding its short dollar position acquired through FX intervention. While the market may be correct in thinking that Banxico does not want the peso to be a lot stronger, we think that after some temporary weakness in September, the peso will still outperform its steep forward curve.
Unwinding the intervention
Late yesterday, Mexico’s central bank, Banxico, announced its plans to unwind the outstanding balances of its FX hedging programme, a programme launched in February 2017 to support the beleaguered peso. During two intervention episodes - February 2017 and March 2020 - Banxico effectively acquired short USD/MXN positions in the FX forwards market when spot was trading over 20 and 24, respectively.
In its press release, Banxico clarified that $5.5bn of its forward position was built during 2017 and another near $2bn during the March 2020 episode to leave the current outstanding balance near $7.5bn. Banxico has said that it will let these short USD/MXN positions in the forward market (held in the one to twelve-month tenors) roll off gradually. In practice, this means rolling only 50%, not 100%, of the shorter-dated positions and allowing the longer nine and twelve-month positions to mature on schedule.
There are probably three reasons why USD/MXN spiked so sharply on the news. The first is that the Mexican peso has been investors' EM darling this year and that long MXN positions are crowded. The second is that Banxico’s decision to unwind this hedge programme could mean Banxico’s tolerance of peso strength has reached some kind of limit. The third is the technical aspect that the biggest impact on the FX market could come this month. If, as Banxico says, only 50% of this month’s reported $4.8bn in maturing forwards is rolled, that means the FX market has to absorb the sizeable impact of a $2.4bn Banxico dollar offer disappearing.
While all of the above concerns have merit, we are less concerned than some and take Banxico’s press release at face value. In it, Banxico said it was now unwinding these positions because market conditions are now orderly and liquidity conditions are good (they weren’t when the intervention took place). And that, by unwinding these positions now, Banxico allows banks on the other side of these trades to do so in an orderly manner.
