MXN Outlook: Banxico's View on a Strong Peso Sparks USD/MXN Rally

MXN: Banxico expressing a view over a strong peso

Unlike Chinese authorities which are battling renminbi weakness and cut the FX deposit required reserve ratio last night, Mexican authorities are seemingly expressing a view that the peso is too strong. Here USD/MXN spiked more than 2% last night after Banxico announced that it would allow its "hedge book" or short USD/MXN position in the FX forward market to roll off rather than be extended. 

By way of background, Banxico has intervened to support the peso during two periods (February 2017 and March 2020) and has done this by auctioning dollars through the FX forward markets using one-month to 12-month tenors. The total size of those positions is now around $7.5bn. Banxico announced yesterday that it would allow this position to roll off gradually, effectively over the next 12 months.

Investors have read this as Banxico expressing a view that the peso has come far enough. And given the peso has been a prime beneficiary of the carry trade, we should not underestimate the risk of a further correction higher in USD/MXN ahead of this long US weekend. Yet USD/MXN has traded below 17.00 for very good reasons, including high carry and nearshoring trends. And given our view that the dollar does turn lower next year, we see the Banxico move as slowing rather than reversing the USD/MXN trend.

Two further quick points: returns on the MXN carry trade may now come more from carry than nominal MXN appreciation, and speculation may grow in the TIIE market (Mexican swap curve) that Banxico may prefer early rate cuts after all if it does not want its currency to strengthen much more.