Mexican Peso trades lower as geopolitical concerns weigh
- The Mexican Peso is trading lower in key pairs on risk aversion from the escalating Middle East conflict.
- Carry-trade outflows on the back of a strengthening Yen are further headwinds.
- Technically, USD/MXN pulls back within a rising channel.
The Mexican Peso (MXN) is trading about half a percent lower in its most-traded pairs on Monday morning as traders arrive at their desks after the weekend break.
Fears of an escalation in the Middle East after a bloody exchange between Israel and Hezbollah is weighing on riskier assets, including the MXN, and the continued appreciation of the Japanese Yen (JPY) suggests more outflows from the carry-trade, of which the Peso has been a key beneficiary.
Mexican Peso benefits from Fed Powell’s Jackson Hole speech
The Mexican Peso experienced a temporary recovery on Friday, triggered by a speech from the Chairman of the Federal Reserve (Fed) Jerome Powell at the Jackson Hole banking symposium, in which he confirmed the Fed would be cutting interest rates. Powell said a noted slowdown in the US labor market was a key reason to lower borrowing costs.
“The timing and pace of rate cuts will depend on incoming data,” said Powell, adding, "upside risks to inflation have diminished, downside risks to employment have increased."
His comments sent the US Dollar (USD) lower in its pairs since the expectation of lower interest rates is negative for a currency as it usually results in a fall in foreign capital inflows. USD/MXN ended the day down over two percent. EUR/MXN and GBP/MXN also fell, but to a lesser degree.
After Powell’s speech other Fed officials chimed in with similar opinions. Chicago Fed President Austan Goolsbee said attention needed to be given to the cooling job market since inflation was now on its way sustainably lower, in an interview with Bloomberg News. Philadelphia Fed’s Patrick Harker said the Fed needed to be methodical in its approach to reducing interest rates, cautioning, perhaps, against any large step-decreases in interest rates.
Overall the Mexican Peso is in a downtrend, and despite Friday’s recovery rally still ended the week substantially weaker in its key pairs. A combination of factors, including cooler-than-expected Mexican inflation data for August, weaker retail sales in July and resurfacing concerns regarding the impact of proposed changes to the Mexican constitution by the new government, have been posited as factors weighing on the currency.
Carry-trade outflows a headwind
The carry trade – which benefited the Peso with high inflows of foreign capital for several years – is unwinding, adding a further negative background factor for MXN. The investment operation involves traders borrowing in a currency where interest rates are low – like the Japanese Yen (JPY) – in order to purchase a currency where interest rates are high – like the Peso.
Assuming no change in the exchange rate, traders pocket the difference between the interest they have to pay on the loan and the interest they earn from the investment. However, given the Japanese Yen (JPY) is now trending higher and the Mexican Peso lower, the carry trade is not as profitable as it used to be, and this is causing outflows from MXN.
Part of the reason for the popularity of the Peso in the carry trade is the relatively high interest rates in Mexico. These, which are set by the Banco de Mexico (Banxico), peaked at 11.25% in 2023. However, the bank has since cut them to 10.75% in two 0.25% reductions.
In August, Banxico surprised markets by cutting rates by 0.25%. The release of the August Banxico meeting Minutes last week, however, shows the decision was only narrowly agreed on, with two of the members of the five-person Banxico board voting against a cut. This suggests further rate cuts may be delayed or implemented at a more leisurely pace – a mildly supportive counterfactor for MXN.
At the time of writing, one US Dollar (USD) buys 19.23 Mexican Pesos, EUR/MXN trades at 21.52, and GBP/MXN at 25.40.
Technical Analysis: USD/MXN pulls back within rising channel
USD/MXN is in a broad uptrend within a rising channel, which overall favors longs over shorts.
After Friday’s decline, however, the short-term trend is unclear and despite the overall bullish technical position there is a risk of more weakness, perhaps back down to the lower channel line at around 18.55. A break below 19.00 would confirm more downside.
USD/MXN Daily Chart
That said, the overall trend on the medium and longer-term time frames is arguably up, suggesting a bullish backdrop. This could easily stimulate a quick recovery and continuation of the up leg seen since August 19, towards a target at the channel highs at circa 20.50.
A break above the 19.53 swing high of August 22 would provide additional confirmation of the continuation of the up leg.
Mexican Peso FAQs
The Mexican Peso (MXN) is the most traded currency among its Latin American peers. Its value is broadly determined by the performance of the Mexican economy, the country’s central bank’s policy, the amount of foreign investment in the country and even the levels of remittances sent by Mexicans who live abroad, particularly in the United States. Geopolitical trends can also move MXN: for example, the process of nearshoring – or the decision by some firms to relocate manufacturing capacity and supply chains closer to their home countries – is also seen as a catalyst for the Mexican currency as the country is considered a key manufacturing hub in the American continent. Another catalyst for 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 maintain inflation at low and stable levels (at or close to its target of 3%, the midpoint in a tolerance band of between 2% and 4%). To this end, the bank sets an appropriate level of interest rates. When inflation is too high, Banxico will attempt to tame it by raising interest rates, making it more expensive for households and businesses to borrow money, thus cooling 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. On the contrary, lower interest rates tend to weaken MXN.
Macroeconomic data releases are key to assess the state of the economy and can have an impact on the Mexican Peso (MXN) valuation. A strong Mexican economy, based on high economic growth, low unemployment and high confidence is good for MXN. Not only does it attract more foreign investment but it may encourage the Bank of Mexico (Banxico) to increase interest rates, particularly if this strength comes together with elevated inflation. However, if economic data is weak, MXN is likely to depreciate.
As an emerging-market currency, the Mexican Peso (MXN) tends to strive during risk-on periods, or when investors perceive that broader market risks are low and thus are eager to engage with investments that carry a higher risk. Conversely, MXN tends to weaken at times of market turbulence or economic uncertainty as investors tend to sell higher-risk assets and flee to the more-stable safe havens.
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