Peso has wall of support

We know that currency markets reflect a combination of fundamental, psychological and technical factors. In these uncertain geopolitical times, separating the “signal” from the “noise” is more difficult than usual. However, this is not the case for the Mexican peso. Price action of the MXN versus the U.S. dollar presents a rare opportunity to view all these forces in action. 

In understanding the Mexican peso, the first lens of analysis to consider is the economy of Mexico, which is doing well. The year-over-year GDP is 2.4%, the Mexican consumer price index of inflation is at 4.72% and unemployment is down to 3.6%. Also, interest rates are at 6.25%. By the metrics that central banks use, this is an economy that is hot. Consequently, there is the fundamental need for a stronger peso to dampen inflation and avoid overheating. The recent action of the Bank of Mexico underscores this analysis. 

The Bank of Mexico intervened on March 6, and entered into the first of what may be several attempts to shore up the peso. The Bank of Mexico placed a $1 billion forward contract (non-deliverable forward) to lock in the value of the peso between 19.5793 per dollar or one month, and a lock to 20.49 per dollar for one year. Mexico’s central bank also announced that another $20 billion in further currency hedges would be available. This, in addition to multiple rate increases in Q1, demonstrates that a free-fall for the MXN in response to fear of Trump immigration and border tax policies is not likely and a weakening peso will encounter strong counter-measures.

The second force impacting MXN price action is psychological. It is manifested in the ongoing theater of the Trump Presidency. The result has been a cascade of fear; where we have drama over The Wall, and fear of potential protectionist policies such as a border-adjustment tax. The result in the USD/MXN currency pairprice action has entered an anxiety-relief expectation cycle. We can see these psychological patterns in the price action (see “Peso responds”). The conventional wisdom that a Trump Presidency is bearish on the Mexican peso has been challenged. Since the inauguration, despite the promise to build a wall, the peso has strengthened against the U.S. dollar. 

Combining the fundamental with the near-term psychological forces generates a good case for going long the peso (short USD/MXN). Traders looking to trade the USD/MXN in the spot market may face higher margin requirements than trading more common currency pairs. Another approach would be to invest in a Mexican peso ETF and bet on a strengthening peso and entertain a position trade. The iShares MSCI Mexico Capped ETF (EWW) provides such an opportunity. It also offers options to enable using the EWW as an income generator using covered-call trading. Finally, the unpredictable and volatile nature of comments, particularly on Mexico and trade, from the new president portends volatility and choppiness in the peso, which presents an opportunity to look beyond the two-dimensional price chart and utilize multiple options volatility strategies.