The Mexican peso’s performance since the beginning of the year is a fantastic example of how quickly circumstances can change in the volatile world of emerging markets.
For a brief few weeks after President Donald Trump’s upset victory in the Nov. 8 U.S. presidential election, the peso was the worst performer among the major emerging-market currencies.
Now, it’s on the verge of breaking into bull market territory as several of the most popular “Trump trades” have violently unraveled since his inauguration.
Since Jan. 19, when the peso
tumbled to an all-time low at 22 to the dollar, the Mexican currency has risen more than 18% against the dollar. Most market participants would consider an asset or currency to be in a bull market if it rises 20% or more off a recent low. One dollar bought 18.52 pesos on Monday, compared with 18.51 pesos late Friday in New York.
This represents an important shift after nearly half a decade of weakness. After peaking against the dollar in May 2013, the peso fell more than 50% over the ensuing four years as expectations that the Federal Reserve would soon raise U.S. interest rates and taper its bond purchases lifted the greenback against many currencies, including the peso.
More recently, the peso has benefited from a confluence of factors both foreign and domestic. In the U.S., an internecine struggle between Congressional conservatives and moderate Republicans has forced investors to recalibrate expectations for how swiftly Trump will be able to implement several purportedly pro-growth elements of his economic agenda, including corporate tax cuts, an infrastructure spending package and deregulation.
Whether he passes some, all or none of these measures before the end of the year could, in turn, influence how quickly the Fed is able to raise interest rates. Typically, higher interest rates cause a currency to strengthen by making it more appealing to foreign investors.
While investors are trying to anticipate how many more times the Fed will raise interest rates during 2017, Mexico’s central bank has already raised borrowing costs by three-quarters of a percentage point. This has been a major selling point for the currency, market strategists said.
Meanwhile, the growing influence of centrist advisers, like Trump’s son-in-law Jared Kushner and former Goldman Sachs Group President Gary Cohn, has helped soften Trump’s protectionist rhetoric — a factor that had weighed on the trade-sensitive peso.
A team of emerging-market strategists at Société Générale lists the Mexican peso as one of its favorite carry trades (the carry trade involves borrowing in a lower-interest-rate currency to fund investments in a higher-rate currency). They believe the currency still has more room to strengthen and that, at 6.5%, Mexico’s benchmark interest rate is attractive both relative to the U.S. and many of its emerging-market peers. The Fed, by, comparison, is presently targeting an interest-rate range between three-quarters and 1 percentage point.
The level of bets that the peso will strengthen has risen to its highest levels since the election, according to data provided by the Commodity Futures Trading Commission. The data encompasses positioning in U.S.-based futures markets.
But just as strife between Republican factions helped upend the dollar’s postelection rally, the peso faces potential political risks of its own.
Luis Hurtado, Latin American strategist at CIBC Capital, believes the currency could encounter some turbulence in the second half of 2017 as the presidential campaign heats up. Mexican President Enrique Peña Nieto is unpopular by some measures, and is facing a strong challenge from populist rival Andres Manuel Lopez Obrador — colloquially referred to as “AMLO.” Mexicans head to the polls in July 2018.
“We see investors starting to focus on domestic risks as the presidential election race gets under way in [the second half of 2017] and populist [AMLO] leads in the polls,” Hurtado said in a recently published research note.