The Mexican peso is experiencing a remarkable surge in value, attracting global investors and reaching levels unseen in recent history. This growth occurs despite potential risks posed by imminent interest rate cuts, politically turbulent elections in both Mexico and the United States, and cautious remarks from financial experts. The peso’s performance has been so stellar this year that it now stands as the world’s most formidable major currency. According to real effective exchange rates by Bloomberg, a gauge of a nation's competitiveness in international markets, the peso's value is at its peak in Mexico since 2005, based on data from Deutsche Bank.
This upward trajectory of the peso has been consistent and strong, breaking through one record after another. This relentless rally has led to a sense of trepidation among investors who are reluctant to wager against the currency despite its seemingly inflated valuation. Insights from options markets suggest a collective anticipation among traders for the peso to continue strengthening over the next quarter, rather than declining.
Nicolas Jaquier, a seasoned portfolio manager at NinetyOne UK Limited in London, shares his insights on the situation. He notes that previous attempts to counteract the peso's strength proved futile. Jaquier acknowledges that, according to various economic models, the peso appears overvalued. However, he advises caution and a nuanced approach to these assessments, hinting at the complexities of currency markets and the potential for unexpected outcomes as we read in Bloomberg.
The peso's allure stems from its stability and low levels of volatility, combined with Mexico's record-setting high interest rates. These factors have made the peso an ideal candidate for carry trades. This investment strategy involves borrowing funds in a low-interest-rate currency and then investing in a currency like the peso that offers higher yields. After recording its most substantial annual increase in over two decades last year, the peso has appreciated further this year, gaining 1.8% against the U.S. dollar. It currently trades around 16.70 per dollar, nearing its highest point since 2015.
Even as Mexico gears up for its presidential elections and the U.S. prepares for its November elections, the peso continues its upward momentum. Political events, especially in major economies, typically introduce uncertainties and risks of sudden policy changes that could impact currency values. However, investors seem to be overlooking these potential disturbances.
This is evidenced by the increasing net-long positions on the peso by asset managers, reaching a peak not seen since late 2022. This trend persists despite warnings from analysts at Deutsche Bank and Bank of America about the peso reaching excessively high valuations, with the former describing it as "reaching extremes" and the latter labeling it "overvalued."
Mexico's central bank is poised to make a notable move by reducing its key interest rate from the current 11.25%, marking the first such reduction in three years. This expected cut is seen as a shift in monetary policy. However, experts like Jaquier from NinetyOne believe that the gradual pace of the rate cut is unlikely to significantly weaken the peso. The high real interest rates in Mexico continue to attract money managers globally, making it financially unviable to speculate against the peso.
Hari Hariharan, the Chief Investment Officer at NWI Management, provides further perspective. He foresees the peso remaining a favored option for investors, particularly those funding their investments by borrowing in other currencies like the yuan, euro, and Swiss franc. He expects this dynamic to persist despite potential volatility stemming from electoral events in both Mexico and the U.S. However, he does not anticipate these events to fundamentally shift the current investment trend in favor of the peso.
The upcoming Mexican presidential election is generating interest, with Claudia Sheinbaum, backed by the current President Andres Manuel Lopez Obrador (AMLO), being widely anticipated to emerge victorious. AMLO's approach to fiscal policy, characterized by austerity, has played a significant role in fortifying the peso, especially as investors around the world are increasingly concerned about rising deficits in both emerging and developed economies.
Supporting the peso's strength are several key factors, including an unprecedented level of remittances flowing from the U.S., Mexico's economic performance surpassing expectations, and growing investments from manufacturers seeking closer proximity to the U.S. market. Christian Lawrence, a strategist at Rabobank, opines that Sheinbaum's potential victory would likely maintain the existing economic policies, ensuring continued stability and strength for the peso.
The U.S. presidential election in 2024, however, poses a more pronounced risk to the peso's trajectory. The election could lead to increased hedging activities against the peso as the election date nears. Recalling the 2016 U.S. presidential election, when Donald Trump's victory led to significant losses for the peso due to his tough stance on trade with Mexico and threats to tax remittances, investors remain cautious.
Trump's current campaign, emphasizing tariffs on imports and heightened trade tensions with China, might inadvertently funnel more investment into Mexico, offsetting some of the negative impacts on the peso.
Dirk Willer, a strategist at Citigroup, provides a broader perspective. He suggests that while the U.S. election will be a factor in shaping investor sentiment towards the peso, it will not be the dominant concern in the short term. The attractiveness of the carry trade, where investors benefit from the interest rate differentials, remains the primary driver of the peso's value.
He also believes that Mexico is less likely to be singled out negatively as it was in previous U.S. election cycles. The focus, for now, remains firmly on the benefits of the carry trade, overshadowing other concerns about the peso's future trajectory.
16.03.2024
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