Payments Perspectives: Volatility Weighing on Mexico’s Peso

In the weeks after the U.S. election, Mexico’s peso took a hit over uncertainty about the country’s relationship with key trade partners--especially its northern neighbor. This could be a good time for financial professionals at multinationals exposed to the peso to assess exchange rate risk as it relates to payments and transfer activity. We examine the currency’s recent volatility and offers suggestions to better manage payments in the face of these uncertainties.

It’s no fiesta right now for the peso. The currency recently dropped to a record low—in part over lingering doubts about the future of US-Mexico trade relations under a Trump presidency. The president-elect’s rhetoric of reducing business ties with Mexico has only fueled these doubts, helping to make the peso one of the world’s worst performing currencies of late. In particular, Trump has been vocal about enforcing tariffs on goods made in Mexico, withdrawing from the North American Trade Agreement (NAFTA), levying taxes on cash remittances from America to Mexico, and building a wall along the border, which he wants Mexico to pay for. 

Mexico is the third-largest trading partner for United States, so needless to say, there is much at stake here for both countries. The two countries have had strong economic ties through NAFTA which has been in effect since 1994; most of the bilateral trade happens in the context of supply chains over manufactured goods across the border. Therefore, if U.S. were to pull out of NAFTA, it would likely have adverse effects on an already battered peso.

For businesses handling cash flows to and from Mexico, strategies around currency conversion should not be treated lightly. Financial specialists should ensure that proper controls are in place to mitigate exchange rate losses stemming from the Peso’s recent volatility. This includes the use of specific financial instruments, as well as comprehensive analytics platforms and related technological tools.

In light of the struggling peso, here are a few recommendations for financial controllers to maximize gains while making FX payments for services rendered by Mexico’s business entities:
 

·       Consider Interest Rates’ Impact: The central bank of Mexico recently raised its interest rate by 50 basis points to 5.25 percent while the U.S. Fed rate has remained relatively stable. With a Fed hike looking increasingly possible, volatility between the Dollar and Peso is likely to resume. Timing major transactions or expenditures to take advantage of interest rate circumstances is one strategy that cash flow specialists can undertake, and one that requires sophisticated analytics tools to optimize.

·       FX Hedging: With a strong dollar in hand, now could be a good time for U.S. businesses to make transactions to clear off outstanding payments. At the same time, it would be wise to lock in a determined purchase at this low rate and hedge future payments.  A ‘window forward’ contract where exchanges can be made on or before a particular date is a good option to undermine market volatility.

Overall, the peso’s volatility as of late could mean opportunity for multinational corporations exposed to the Mexican currency. Financial professionals at these organizations will want to plan transactions carefully and structure them in a way that will optimize FX rate considerations. FX forwards indicate that the peso could continue to depreciate and disrupt the balance of existing payments structure.