Mexican Peso declines against USD after higher-than-expected US GDP data
|- The Mexican Peso trades lower on Thursday, continuing the trend of recent days.
- The Peso falls against the US Dollar after the release of strong US GDP and Jobless Claims data.
- Mexico’s high interest rates still attract carry-trade inflows, despite the Peso weakening.
The Mexican Peso (MXN) weakens in its most heavily-traded pairs on Thursday. US data suprised investors by coming out stronger than expected with Q2 Gross Domestic Product (GDP) suprising to the upside and Initial Jobless Claims revealing a still resilient labor market.
Mexican Peso weakens against USD after data beats expectations
The Mexican Peso weakens in its key pairs, particularly versus the USD on Thursday after the release of US data suggests the US economy is not heading for a hard landing as some economists had feared.
The second estimate of Annualised US Q2 GDP came out at 3.0%, beating the 2.8% of the preliminary estimate, and expectations of the same. US Initial Jobless Claims fell to 231K from an upwardly revised 233K in the prior week and was below expectations of 232K.
The data indicates the US economy is in better shape than some had feared and that the labor market is still quite bouyant. It has slightly decreased the odds of the Federal Reserve (Fed) making a mega 0.50% cut to interest rates in September from 34.5% to 32.5% according to the CME FedWatch tool. The expectation that interest rates will not fall as steeply as expected is supportive of the US Dollar since higher interest rates attract greater inflows of foreign capital.
At the time of writing, one US Dollar (USD) buys 19.90 Mexican Pesos, EUR/MXN trades at 22.01, and GBP/MXN at 26.16.
Mexican Peso upside limited by political risk
The Mexican Peso may see upside potential limited by political risk factors. The government’s proposed reform to make judges and magistrates elected by popular vote has been criticized as undermining justice, democracy and investor confidence in Mexico.
Disagreement over the reforms has led to public demonstrations in Mexico City by members of the judiciary. The US ambassador to Mexico, Ken Salazar, said the “popular direct election of judges is a major risk to the functioning of Mexico's democracy.”
The Mexican government chose to “pause” diplomatic relations with both the US and Canada on Tuesday due to disagreements over the reforms. If the stand-off escalates, there is a chance it could negatively impact free trade between the three countries, with negative implications for the Mexican Peso.
At the same time, the Peso could benefit from an escalating trade war between North America and China. News on Tuesday revealed that Canada has decided to increase tariffs on Chinese electric vehicle (EV) and steel imports, by 100% and 25%, respectively.
The decision could benefit Mexico, however, because of its existing role as an intermediary manufacturer for Chinese goods entering North America.
Mexican Peso gains back wind from interest-rate differentials
The Peso is further supported by the high level of interest rates set by the Bank of Mexico (Banxico) at 10.75%, compared to counterparts. The interest-rate differential has gained particular importance as expectations increase that the (US) Federal Reserve (Fed) will make deep cuts to interest rates in the US.
According to data from the Chicago Board of Exchange (CBOT), for example, the market is pricing in 1.00% of cuts by the Fed before year-end. This would bring its key fed funds rate down from 5.25%-5.50% to 4.25%-4.50%, further widening the differential with Mexico. That said, the Banxico is also expected to cut interest rates, though according to advisory service Capital Economics, not as steeply as the Fed (0.50% by year-end instead of 1.00%).
Overall, the differential continues to favor foreign capital inflows into the Peso, although the Peso’s recent weakness has reduced the popularity of the MXN carry trade.
Technical Analysis: USD/MXN
USD/MXN continues its uptrend within a rising channel. Given “the trend is your friend” this favors longs over shorts.
USD/MXN 4-hour Chart
The pair has broken above 19.80, the August 27 highs, and this confirms more gains towards the next target at the upper channel line in the 20.60s.
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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