The Mexican peso started the last quarter of the year by gaining ground against the US dollar after it stopped oscillating around 20.14. The peso gained ground significantly from October 31, when the country reported robust GDP growth from 2.0% to 4.2%, making the currency the strongest against the US dollar. Subsequently, the peso continued appreciating and reached an exchange rate of 19.43473 on November 7, its best level since May.
From that point onwards, the Mexican peso remained strong, driven by the country’s high interest rates that had favoured the currency throughout the year due to its attractiveness for the carry trade. Inflation data remained high, so when on November 9, a 0.29% drop in inflation was reported, it prompted the Bank of Mexico (Banxico) to extend its aggressive monetary policy by hiking interest rates by 75bps the day after the inflation figure, bringing its lending rate to 10.00%.
It seems that the decision made by Banxico to hike interest rates paid off since, on December 8, inflation data registered a 0.61% decline, starting a deflationary trend that made the peso continue trading below 20mxn per dollar. However, the optimism around the peso has diminished since the December 15 rate hike of 50bps.
Within the minutes of the November monetary policy decisions, most policymakers mentioned that they anticipate a moderate recovery in the global economy due to the reopening of some cities in China. However, they also highlighted the risks associated with the postpandemic era, including geopolitical tensions and the monetary positions of other central banks, such as the Fed, that remain tight.
Furthermore, policymakers also mentioned that many central banks will likely keep raising interest rates, although some to a lesser extent than expected, throughout 2023.
It is also important to note that Banxico’s largest rate hikes were aligned with the Fed’s decisions by 75 basis points, and we should also mention that the central bank expects the Fed to start slowing down the pace of future interest rate hikes. To determine the future direction of the Mexican peso, we should watch the accumulated monetary policy tightening and the economy’s performance along with that of the financial markets.
The Bank of Mexico (Banxico) is now forecasting a higher interest rate than anticipated and is likely to maintain its rate hike stance while still keeping an eye on critical economic data.
On the other hand, conditions for the Mexican peso have been favourable because the Mexican economy recovered and expanded during the third quarter, as it did in the previous two quarters. It is also worth mentioning that much of the peso’s strength in this last quarter was because economic activity returned to pre-pandemic levels. In addition, manufacturing activity showed good progress as private consumption and demand for domestic goods and services was reactivated.
Another factor that set the tone for the Mexican peso’s impressive performance was that foreign remittances continued at high levels, fueling the sale of US dollars for Mexican pesos.
After seeing a drop in the dollar towards 19.03957, the markets opted to end the year with high demand for dollars, sending the USD above 19.70. Given that the USDMXN pair usually moves sideways for medium periods, we can expect the price to respect the 19.60 and 19.80 levels before the end of December and to start January with some volatility based on US data.
2022 is set to end with the peso appreciating close to 3.5%, which is a good result. However, we could see the peso weaken in 2023 and fall towards 20.48, which was the starting level of 2022, driven by an increase in USD purchases as the Fed hikes interest rates and US Treasury bond yields rise.
At the time of writing, the Mexican peso had weakened to 19.7 per dollar, approaching the seven-week low of 19.8 hit on December 12. The dollar had recovered from its recent lows as investors digested the Bank of Mexico’s monetary policy decision.
As widely expected, the Bank of Mexico raised its benchmark policy rate by 50 basis points in December, raising borrowing costs to record highs. The decision coincided with the Federal Reserve’s decision to hike rates for the sixth consecutive time. Banxico was keen to limit the difference between its rates and the Fed’s to reduce capital outflows and support the Mexican peso.
Monetary policymakers also signalled that they will continue to raise interest rates in 2023 to curb rising inflation. However, they also noted that inflation will continue to decline, although the latest forecasts indicate that price growth will converge to the central bank’s 3% target by the fourth quarter of 2023.
With all the above, we forecast that as long as the Mexican peso remains below 20.20, it will remain strong as in this zone, trade volumes tend to decrease, and the 20.01 level remains the focal point. On the other hand, the price action has generated some wicks in the 19.80 zone, fueling some sideways movement that could send the dollar back below 19.60.
By Eduardo Ramos, ATFX LATAM Market Analyst
Created by newsroom | Jan 17, 2023
Created by newsroom | Jan 17, 2023
Created by newsroom | Jan 17, 2023
Created by newsroom | Jan 17, 2023