H2 Currencies to Watch: Peso Poised for a Comeback

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This is the second installation in a six-article series on what businesses need to know about key global currencies in the second half of 2018. Sign up for our weekly FX newsletter to get these articles sent straight to your inbox.

In this article, we'll take a dive into what'll drive the Mexican peso in H2, with a focus on political, economic, and financial events that will affect the Mexican currency. Here's what global businesses will need to watch in the coming months.


Mexico finds itself right in the middle of the U.S. war on trade, as President Trump seeks to find a better balance on trade and tariffs for U.S. companies.

Trade tensions, coupled with Trump's desire to renegotiate the NAFTA treaty between the U.S., Mexico, and Canada, could trigger significant volatility in the Mexican economy after 15 years of relative stability.
 

Serious Challenges for the Mexican Currency

It's not only NAFTA and trade that threaten the stability of the Mexican peso. A roiling presidential election held on July 1st could greatly impact the Mexican economy and the peso. In addition, the rate of inflation in Mexico is alarmingly high - it finished 2017 at 6.7% and has receded to 4.5% in the second quarter of 2018.

Other Articles in this Series

Wall Street firms are trying to get ahead of the twin issues of politics and inflation by issuing downgrades to the peso in mid-2018. The good news is that now the election is settled, and Andres Manuel Lopez Obrador has been declared the winner with 53% of the popular vote, the Mexican economy can regain some stability, and inflation can continue to decline (Obrador takes office on December 1st , 2018).

“We expect both headline and core inflation to continue to decline at a brisk pace throughout 2018," states BBVA in a recent research report . “We anticipate that headline and core inflation will be below 5.0% and 4.0%, respectively, in April, and below 4.0% (at 3.8%) and 3.5% (at 3.3%), respectively, at the end of the year, below the upper limit of variability of the central bank target. In this context, the end of the rate increase cycle is approaching."

 

NAFTA a Roadblock for Peso

The larger shadow looming over the peso is the NAFTA renegotiations, which are currently in a holding pattern in mid-July, with uncertainty surrounding the issue knocking the peso down a peg or two.

     "The uncertainty surrounding a
      possible NAFTA 2.0 has prevented
      further appreciation of the peso."

“The main risk continues to be associated with the NAFTA renegotiation process," BBVA states. “The slow advances, if extended, will continue to delay the recovery of investment and to affect the exchange rate. In fact, the uncertainty surrounding a possible NAFTA 2.0 has prevented further appreciation of the peso."

While trade negotiators from Canada, Mexico, and the U.S. have experienced some success in nibbling around the edges and making some changes on NAFTA, major changes to the trade agreement are another story.

“Both Mexico and Canada know that a NAFTA 2.0 will not be reached without changes in the rules of origin in the automotive sector, and for the moment, the U.S. is showing no flexibility," BBVA reports. “The risks of a collapse continue to decline, but those of prolonged negotiation have increased.
 

Mexico Boosting Interest Rates

On June 21, the Central Bank of Mexico lifted already sky-high interest rates to 7.75%, the second interest rate hike in 2018. Currently, benchmark Mexico interest rates are at their highest levels since February 2009. Only four years ago, the central bank's main interest rate stood at 3%, and currency watchers have reason to be concerned over a more-than-doubling of the interest rate from June, 2014 to June, 2018.

     Mexico has more than doubled its
     interest rate in the last 4 years.

The rate hikes were widely viewed as a response to high inflation and a devalued peso, along with continued uncertainty over the future of NAFTA and higher energy prices through the country.

On the upside, the International Monetary Fund recently adjusted estimated Mexican gross domestic product for 2018 upward, from 1.9% to 2.3%, primarily due to a “spillover" effect of U.S. tax cuts implemented in late 2017, which should favor a close U.S. trading partner like Mexico.
 

A Search for Stability

While Mexico is experiencing some turbulent economic times, economists see stability ahead for Mexico and for the peso, as the government has taken active steps to rein in inflation and tighten the national budget.

With NAFTA as an x-factor, however, economists don't know for certain the exact direction of the Mexican economy. Until major trade issues are resolved, expect the peso to continue giving ground as Mexico continues to get its financial house in order during the second half of 2018.

Additionally, with a trio of economic impactors–rising rates, high inflation, and the NAFTA talks – all in play, global businesses may want to take a “wait and see approach" to Mexico, until economic conditions south of the border find some much-needed balance.


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