Macro and Vol Commentary
The Mexican peso is back on the upward trend against the dollar again, trading at 16.90, the level not seen since 2015. As the monetary policy divergence between the Fed and Banco de Mexico is coming to an end, what is the outlook for one of the best performing currencies this year?
Mexican Economy
- Mexican economy performed better than expected in Q2’23, maintaining growth at 3.7% YoY despite weakening global economic environment.
- While Q2 marked a deceleration in services, growth in both manufacturing and agriculture picked up.
- In July, manufacturing PMI rose to 53.2 from 50.9 in the previous month, marking the highest reading since May 2016. Non-manufacturing PMI clocked in at 51.7 in July, up from June’s 51.5.
- Growing factory activity in Mexico contrasts with developed economies where manufacturing activity continues to show signs of contraction.
- The economy has now posted seven straight quarters of growth.
- The second-largest Latin American economy faces further tailwinds as firms look to reshore production from Asia to Mexico in order to secure easy access to the US market.
- Gross fixed investment grew 17.4% in May compared to 6.2 the previous month and well above the expectation of 9.7%.
- Albeit moderating, the overseas demand remains robust, highlighting strong underlying fundamentals in Mexico.
- In June, exports stood at $51.8 billion, lower than the $52.9 billion figure in May but still at a historical high.
- Sales of manufacturing products, which represent 89% of total shipments, increased by 2.7%.
- At the same time, while softening of the US labour market led to a slight decline in remittances, the number still stands close to record high. Transfers from the US represent 95.5% of remittances arriving in Mexico.
- The June figure stood at $5.57 billion and dampened in real terms by the sharp appreciation of peso against the dollar.
- Despite moderating US economic performance, the robust Mexican domestic market puts the economy on a much stronger footing to take the risks of a rising recessionary environment.
- June retail sales data surprised on the upside, at 5.9% YoY compared to a 2.6% reading in the previous month.
- The reading was boosted by strong sales of textiles and jewellery as well as increases at self-service and department stores.
- Consumer confidence edged higher at 46.2 in July compared to 45.2 in June as unemployment rate remains at a historical low.
- The labour market continues to show signs of strength with healthy job gains. Total employment, representing 58.5 million workers, grew 4.3% YoY in Q1’23.
- In June, the unemployment rate edged lower at 2.65%, pointing to a decade low reading.
Central Banks
- In May, Mexico’s central bank ended its monetary policy tightening despite further interest rate increases from the Fed.
- Mexican policymakers agreed on the need to keep the interest rate at 11.25% for a prolonged time, stressing persistent risks to inflation that could resurface if the CB decides to cut interest rates too early.
- Headline inflation has been decelerating steadily since the start of the year, falling to 4.79 YoY in July.
- At the annual Jackson Hole Economic Symposium last week Jeremy Powell reiterated that inflation risk was to the upside, suggesting that the Fed might implement one more interest rate increase before the end of the year.
- Now markets are pricing in about 45% chance of a rate hike by November.
- In our view, a robust labour market is not enough to suggest that further tightening is still needed and if the price softness is sufficient, the rhetoric for further pauses is more likely to pertain.
Despite recent dollar strength, solid domestic and overseas performance as well as record high remittances have pushed the Mexican peso to appreciate against the greenback, breaking the 16.9 level and hitting an 8-year low. While our base case for the dollar remains that of resilience as ‘the last man standing’ amid growing recessionary fears, Mexican GDP growth and historically low unemployment rate is putting the economy on a much better footing to take the upcoming risks. In our view, MXN is set to continue to gain ground until the US labour market start to show signs of significant weakening.
Sources: S&P Global, INEGI, Banco de Mexico
Volatility Comment
MXN has been on an upward trend against the USD since 2020 as CB raised rates from 4% to 11.25% over the past few years to tackle stubbornly high inflation. We have seen a period of consolidation above the strongest level since 2015 as higher for longer rhetoric in the US has given recent support to the USD. However, the peso has been the strongest EM currency this year after COP. The higher rates will continue to attract investment and new business operations are expanded in Latin America from Asia to secure easy access to the US market. Recent growth data is surprising to the upside and employment rate to the downside which shows goods and labour market performing well.
We are looking for a continuation of the recent trend with a break of 16.90 then 16.62.
Implied vols are 5% lower than back in March. So we favour going long vol with a short bias. Furthermore, a strategy buying the higher yielding MXN will mean a lower premium.
USDMXN 1-month Realised and Implied Volatility
USDMXN Trade Idea
- BEAR PUT SPREAD
- 3m Expiry
- BUY USDMXN 16.60 PUT
- SELL USDMXN 16.00 PUT
- PAY 0.68% of USD notional
- Potential max pay off 3.10% of USD notional
Positioning Charts
EURUSD Vanilla Positioning Data 16/08/2023 - 23/08/2023
EURUSD option positioning remained broadly unchanged in the week ending August 30th, only with the range shifting slightly leftwards following the recent move on the downside. The size of the notional further down the line suggests diminishing interest for contracts down the curve. At the same time, while the size of the notional reduced in the near-term expiry, the number of both calls and puts increased, highlighting the more cautious approach from investors. We expect the pair will continue to trade within the current ranges in the near term.
EURUSD Vanilla Positioning Data 23/08/2023 - 30/08/2023
USDCNY NDO Positioning Data 16/08/2023 - 23/08/2023
USDCNY's positioning narrowed significantly in the week ending August 30th, with the number and the size of notional reduced, suggesting a lessening appetite for currency trading. Still, the number of calls exceeds puts, especially over the longer-term, and we suspect the market will maintain a moderately bullish position due to relative dollar strength. In the near-term expiry, the range tightened to 7.20-7.40, and we expect trading to remain rangebound in the meantime.
USDCNY NDO Positioning Data 23/08/2023 - 30/08/2023
USDMXN Vanilla Positioning Data 16/08/2023 - 23/08/2023
USDMXN positioning data saw trade ranges narrow in the week ending August 30th, do to 16.50-17.50, given the recent move on the downside. The conviction around these levels grew stronger given the size of the notional, with a greater number of call options suggesting that the support at 16.50 might be robust. This trend is seen intensifying over the longer term, especially for trades beyond September. We expect the pair to retest the 16.50 level in the meantime before a change in trend on the upside in the longer-term.
USDMXN Vanilla Positioning Data 23/08/2023 - 30/08/2023
Charts and Tables
FX Expiries
Historical Spot FX Volatility (30D Rolling)
FX Matrix (today)
Weekly Change
Key Events & Releases
