- The Exchange Commission Discomfort with the MXN – As part of its International Reserve Reduction Mechanism, every three months Banxico announces a daily amount of USD reserve sales based on a simple, transparent formula established since 2003. Arguing the need to compensate US$8.0bn taken from international reserves used by the Ministry of Finance to buy currencies for different federal government needs, on July 25, the exchange commission announced a suspension of USD sales in the upcoming quarter. Only two weeks ago the exchange commission had announced (as it does every three months since 2003), that the central bank would be increasing its USD sales from US$32mn up to $40mn a day in the August-October period. Although the amount is marginal compared to daily USD/MXN spot average trading volume of around $40bn, the move represents an important policy shift and
signals the authorities’ discomfort with the current exchange rate levels. Although at this point it is unclear whether the Mexican government will undertake further measures to limit MXN appreciation it may ultimately depend on the MXN behavior in coming weeks. - Global Commodity Prices could Edge lower – Commodity prices have clearly benefited the MXN in recent months. However, commodity and oil prices could edge lower especially as the US Federal Reserve needs to hike rates. The prospect for higher US rates will likely be increasingly incorporated into expectations in coming weeks especially if the economy exhibits signs of
stabilization. - Currency Move Overshot Spread Widening – The substantial widening of the Mexico-US interest rate differential has provided an attractive “carry trade” opportunity for investors, likely contributing to recent MXN strength. However, analysis of the currency pair and relative rates suggests that MXN strength now appears moderately “overdone”. The spread initially widened on the back of Fed easing in late 2007 and early 2008. In the last few months, a deterioration on the domestic inflationary outlook and, consequently, inflation expectations forced the Mexican central bank to adopt a more hawkish monetary policy stance that led to a couple of hikes in local interest rates. Thus, the annual yield on the two year TIIE swap has increased
from 7.44% in late March to 9.05% currently. The particularly fast move from 10.30 towards 10.00 in recent days can also be partly attributed to targeting of key options barrier levels at 10.10, 10.00 and below. However, the recent policy shift announced by the exchange commission is likely to discourage some of these inflows, not only preventing a further peso appreciation but likely weakening it slightly. Likewise, the release of the global indicator of economic growth (IGAE) will likely show a continuous drift lower – in addition to the inevitable drop due to one time April strength. - The potential for a lack of advance in the energy sector reform amid a significant decline in Mexico’s oil production is an additional source of concern. Despite high international oil prices, the Mexican oil sector—a key driver of growth —continues to slide, with production
down 9.7% yoy in 1H 2008. The decline is driven mostly by a decline in the Cantarell oil field. - Investors Are Long MXN – Finally, the MXN also remains susceptible to unwinding of historically large long futures position. A relatively small move higher in USD/MXN would likely be magnified by the unwinding of these positions.
- Accordingly, establish long USD/MXN exposure at 10.05 with a target of 10.60 – a level reached earlier in the year and within sight over the medium term.
Forex Strategy: Establish Long USD/MXN
July 29th, 2008 · No Comments
Tags: FOREX Strategies
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