USDMXN: Could peso benefit when NAFTA risks subside?

13:15 28 August 2018

Summary:

  • Mexican peso is placed among the most undervalued EM currencies

  • NAFTA deal could benefit MXN

  • MXN could be less vulnerable to risks related to higher USD rates

  • 100WMA seems to serve as support for USDMXN bears

Recent weeks have not been successful for EM currencies. Among reasons standing behind their struggles were: currency crisis in Turkey, rising trade tensions between the US and China, NAFTA break-up risks and all of those with  rate hikes in the US in the background. The last thing is particularly important as monetary tightening in the US is the more longer-term factor increasing risks for countries having a significant part of external debt in the overall debt level. Looking from the Mexican peso point of view NAFTA talks have been equally important like rate hikes at its neighbour, hence now that a notable progress has been made the MXN could be in a position to continue climbing against the US dollar. In this analysis we outline some reasons behind such thinking.

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Let us remind that at the beginning of the year the Mexican peso was placed among those currencies which could stand out the most, according to analysts surveyed by Bloomberg. Indeed, the peso has gained almost 5% so far this year being the best EM currency (the second Colombian peso has increased nearly 2%) and this performance has come despite risks regarding NAFTA-related uncertainty as well as a presidential election taking place in July. Looking ahead, it seems that the peso could continue climbing along with disappearing trade talks risks.

The MXN is placed among currencies featuring the highest real interbank deposit rate remaining simultaneously the most undervalued currency among selected ones. Source: Bloomberg, XTB

Taking into account inflation rates when analyzing EM currencies is particularly important as many developing countries tend to experience heightened price growth which undercuts a real rate of return. However, real rates do not seem to be a sufficient indicator in assessing investment opportunities because other factors such as politics, macroeconomic stability and economic performance do matter as well. Let’s begin this analysis with the useful chart presenting selected EM currencies in order of a descending real interest rate (the Turkish lira has been deliberately excluded for obvious reasons). This chart suggests that the Russian ruble has the most attractive rate of return which is a combination of contained inflation and relatively high policy rates. Nonetheless, the Russian economy heavily relies on oil prices therefore is subject to much more severe downturns should global demand slow down. It needs to be said that over the recent 10 years Russia has increased its oil output whereas Mexico has dialed back its production by more than one third. Russian oil production was more than 5-fold larger than Mexican in April. In turn, the Indonesian rupiah has been affected by weak economic growth being a by-product of weaker than estimated exports. As a consequence, the Indonesian currency has lost over 7% against the US dollar since the beginning of the year. Do notice that despite the decline we have seen thus far this year the IDR seems to remain less undervalued compared to the peso according to the Z-Score indicator (based on the data provided by the Bank of International Settlement). Looking at these currencies from this point of view it turns out that the Mexican peso is the most undervalued with the Z-Score falling below -1. Hence, looking for a balance between a real interest rate and currency valuation it appears that the MXN is the best choice.

In addition to the above-mentioned it needs to be said that the political outlook in Mexico has clarified since the general elections in July after Andres Manuel Lopez Obrador won the presidential race. The peso appreciated in the following days after the Obrador’s election as he could be more market-friendly than feared. Notice that Obrador has vowed to crack down on corruption, rein in Mexico’s war on drugs and rule for the poorest fraction of society. Yet prior to the elections in July Obrador said he would respect investors and not to expropriate properties (the case taking place in South Africa).

Another reason why the peso could continue appreciating against the US dollar is the progress made in NAFTA talks. Based on some revelations coming from the US side the two countries have already struck a preliminary accord so as to revamp one of the most famous free trade agreement. Note that one of the most contentious points, concerning content of the parts in cars being sold in North America, has been agreed upon bolstering chances to get the final deal before long. Writing about NAFTA negotiations it is worth making a point of importance of any binding trade agreements in the world full of trade tensions. Thus, by striking the deal with the US Mexico could be in a better position compared to Asian countries let alone Russia (almost 97% of Mexican exports go to the US). The former group tends to have strict trade relations with China against which the US is waging trade war.

Mexico has its external gross debt to GDP well below the peer group average which could matter aming rising USD rates. Source: Bloomberg, Macrobond, XTB

Another point being worth looking at is the level of gross external debt to GDP in some developing economies. Why can it be so important? A chunk of external debt is denominated in US dollars therefore interest expenses go up once USD rates increase. The higher share of external debt in an economy, the higher sensitivity to the pace of rate hikes by the Federal Reserve. As of the end of the first quarter of this year Mexico’s gross external debt to GDP totalled 37% being well below the selected countries’ average. On the other flip side, Hungary, the Czech Republic, Poland and Malaysia had their ratios above the mean. Taking into account that the Federal Reserve will be hiking interest rates over the couple of quarters this hallmark could play a role in assessing the balance of risks among EM currencies - the MXN seems to hold an advantage in this field.

Putting the all above-mentioned we think that selling rallies could be a noteworthy approach in case of the USDMXN. Notice that the pair has tended to respect its 100-week moving average recently hence one may suppose that this line could serve as a resistance for bears. Given that timing for entering a short does not seem the best we recommend considering to place a short limit order at a price of 19.30, a stop loss at 20.00 and a take profit at 17.50. Keep in mind that breaking down the lower boundary of the blue channel appears to be prerequisite to see the pair well below the current levels. Source: xStation5

This content has been created by XTB S.A. This service is provided by XTB S.A., with its registered office in Warsaw, at Prosta 67, 00-838 Warsaw, Poland, entered in the register of entrepreneurs of the National Court Register (Krajowy Rejestr Sądowy) conducted by District Court for the Capital City of Warsaw, XII Commercial Division of the National Court Register under KRS number 0000217580, REGON number 015803782 and Tax Identification Number (NIP) 527-24-43-955, with the fully paid up share capital in the amount of PLN 5.869.181,75. XTB S.A. conducts brokerage activities on the basis of the license granted by Polish Securities and Exchange Commission on 8th November 2005 No. DDM-M-4021-57-1/2005 and is supervised by Polish Supervision Authority.

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