Covering the Spread: New Life for Peso Under Trump’s NAFTA?

As tensions with Mexico flare over the proposed border wall, Trump has signaled his desire to pay for it with a 20% tariff on imports. This only adds to near-term uncertainty for the Mexican peso, which had enjoyed a recent rally against the dollar. What does this mean for companies with cash flows exposed to the peso? We offer insight on how firms might rethink their FX strategies in light of these challenges. 

In his first days as President, Donald Trump made good on promises to overhaul American trade policy by withdrawing from the Trans-Pacific Partnership (TPP), a key trade deal negotiated by the previous administration. In doing so, he made it clear that this would be just the beginning in a series of aggressive moves meant to bolster US competitiveness on the world stage.  

The next trade pact in Trump’s sights is likely to be NAFTA, the centerpiece of commerce among the US, Mexico and Canada. While highly unlikely to be scrapped entirely, observers are expecting terms to be redrawn to align more closely with US economic interests. 

How this would play out remains to be seen, but it has certainly contributed to ongoing currency volatility between the US and its neighbor to the South, with dollar-peso exchange rates pivoting on every word (and tweet) from the new American leader. Early indications were that a Trump presidency would be catastrophic for the peso, with the dollar soaring to record highs against Mexico’s currency. Since then, the peso has rallied on the belief that Trump’s brand of protectionism might actually favor a weaker, more affordable dollar.

With more companies than ever doing business in Mexico, volatile spreads will continue to vex those overseeing cash flows to and from the country. This is especially true for small and mid-size operations without access to large, sophisticated FX management teams. Consider the case of a Texas-based manufacturer of automotive parts considering—for logistical purposes—whether or not to shift production to Mexico.

 Under the current arrangement, goods produced more cheaply in Mexico may be exported to the US tariff-free. Should a revised NAFTA incentivize domestic production, a stronger, more autonomous peso would make the various input costs (land, labor, materials) more expensive for the manufacturer. Along with interest rates and other considerations, it may make more sense for production to happen on US soil once currency conversions are taken into account. 

Of course the real-world circumstances are much more complex than this, but being able to forecast and manage the FX implications of major business decisions in real-time can help small and mid-size multinationals remain competitive in any economic climate. Automated exchange rates and advanced analytics tools that were once the in-house advantage to the largest global players are now accessible to an unprecedented number of companies regardless of size or scope.

Whichever direction the peso moves versus the dollar, corporate financial professionals need to be ready to respond in near real-time, especially in such an unpredictable, rapidly changing political situation. A capable API for FX, with a reliable data feed about the latest currency movements, is one of the first steps that a company can take to protect itself against FX volatility.