Mexican Peso Finds Stability Amid Expectations of Interest Rate Increases
The Mexican peso has shown consistent progress against the US dollar in 2023. However, it appears to have reached a point where further gains are limited due to expectations of interest rate hikes by the Federal Reserve (Fed).
Officials from the US central bank have made it clear that their intention is to raise interest rates at least once more in order to bring inflation down to its target of 2%. This has had an immediate impact on the peso-dollar exchange rate, which has remained within a narrow range.
“Since last week, we have seen a neutral peso. After reaching a low not seen since 2015 at 17.02 units, its trading has remained sideways between the levels of 17.25 units, its previous support, and 17.10 pesos,” explained Eduardo Ramos, a technical analyst at the broker ATFX.
Waiting for the Next Move
The end of the monetary tightening cycle in Mexico has put traders in a state of uncertainty. Market participants believe that the Fed will only raise rates once more in July, according to CME Group’s Fed Watch tool, after a series of 10 consecutive rate hikes.
“Last week, the Bank of Mexico kept the reference rate unchanged at 11.25% as expected. This suggests that Banxico may maintain the current level for an extended period,” said Larry Browne, an analyst at trading broker Hantec Markets.
Uncertainty Surrounding the Monetary Context
Many experts have emphasized the significance of interest rates in the recent appreciation of the peso. The carry trade, which takes advantage of the interest rate differential between two currencies, has played a key role in driving the local currency’s value higher.
“Banco de México took the lead by tightening monetary policy when inflation started to rise. They raised rates before the Fed, with higher average increases of 50 basis points,” Browne explained.
“The high interest rates in Mexico, compared to those in the United States, contributed significantly to the peso’s appreciation. However, with the exchange rate at such a low level, traders are now assessing how much further it can drop, taking into account the impact on the trade balance,” added Ramos from ATFX.
Consolidation and Expectations
Compared to the official close of 19.5089 units in December, the peso’s recent low of 17.0219 pesos represents a gain of 2 pesos and 49 cents or 12.74%, according to data from the Bank of Mexico (Banxico). However, the exchange rate has remained relatively stable in recent days, with minimal fluctuations.
Although the peso is currently trading close to its December 2015 low, there has been no significant change. The market believes that levels below 17 are not sustainable given the economic context, resulting in a consolidation phase with reduced volatility.
Consolidation occurs when the price of an asset reaches a level that creates uncertainty about its future direction. Traders hesitate to make decisions, leading to stability in the price. However, market participants are eagerly awaiting a catalyst that could break the consolidation and create a new trend.
Market Expectations and Factors Influencing the Peso
Speculative net positions in favor of the peso on the Chicago Stock Exchange have increased by over 25%. This indicates that the market considers other factors, such as debt levels, investment, and the nearshoring effect, as reasons for the peso’s appreciation.
“With a weak dollar and low local inflation, it is difficult to ignore the potential for further strengthening of the peso, especially in the short term. The nearshoring trend and a strong job market in the US could provide additional support,” said Browne of Hantec Markets.
Federal Reserve, and this attracted foreign investors looking for higher returns. This increased demand for the peso and pushed its value up,” explained economist Maria Gonzalez.
However, with expectations of interest rate hikes by the Fed, the carry trade may no longer be as attractive. Higher interest rates in the United States would make the dollar more appealing, reducing demand for the peso and potentially leading to a depreciation.
As a result, the Mexican peso is currently in a state of stability, with limited gains against the US dollar. Traders are eagerly awaiting the next move by the Federal Reserve to gauge the future direction of the exchange rate. The uncertainty surrounding the monetary context, especially in relation to interest rates, is a key factor driving this stability.
How does the Federal Reserve’s interest rate policy impact the value of the Mexican peso?
The Federal Reserve’s interest rate policy can have an impact on the value of the Mexican peso through various channels.
1. Interest rate differentials: When the Federal Reserve increases interest rates, it attracts more foreign investors looking for higher yields on their investments. This leads to an increased demand for the US dollar, which strengthens the currency. As a result, the value of the Mexican peso may decrease relative to the US dollar.
2. Capital flows: Higher interest rates in the US can incentivize investors to move their money from countries with lower interest rates, such as Mexico, to the US. This capital outflow can lead to a decrease in the value of the Mexican peso.
3. Trade and investment: Changes in interest rates can also impact trade and investment between the US and Mexico. If the Federal Reserve raises interest rates, it can lead to a stronger US dollar, making Mexican goods relatively more affordable for US consumers. This can boost Mexican exports and increase the demand for the Mexican peso, leading to an appreciation of the currency.
4. Confidence and stability: The Federal Reserve’s interest rate policy can indirectly influence the perception of stability in the US economy. If the Federal Reserve is seen as maintaining stable economic conditions through its interest rate policy, it can increase investor confidence in the US. This confidence can attract more investment in the US and strengthen the US dollar, which may result in a depreciation of the Mexican peso.
Overall, the Federal Reserve’s interest rate policy has the potential to influence the value of the Mexican peso through interest rate differentials, capital flows, trade and investment, as well as market confidence and stability in the US economy.