Forex Investment and Currency Trading

1 – 3 Month Outlook: MXN volatility here to stay

MXN has not escaped the current broad-based flight from EM risk, USD/MXN spiking 15%+ since early-Aug. With U.S. (and global) recession risks rising and the view is that the risk reduction / de-leveraging cycle will last another 3-6 months, the MXN will remain hostage to external forces (the USD, core equities, oil prices) given its tight economic / financial links to the U.S. The USD/MXN forecasts for 08Q4 are 11.25 and 11.60, respectively, with the view that the current move could be a short-term overshoot but the 12-18 month trend is clearly higher.

Mexico finds itself in a highly vulnerable position. First, its manufacturing / export driven economy relies heavily on U.S. import demand (manufacturing output averaged just +1.2% y/y in May-July). Second, a high percentage of key capital (FDI, portfolio, foreign worker remittances) inflows are sourced from its northerly neighbour. Lastly, its financial sector is dominated by U.S./European banks, who are facing severe balance sheet pressures and are likely to cut back on deploying capital to their foreign subsidiaries. This will sharply curb domestic credit extension, compounding the negative impact of a sharply decelerating manufacturing engine.

A number of factors should cushion against any major MXN weakening, including a relatively less crowded foreign positioning, possible Oct/Nov energy reform passage, a balanced fiscal position, limited risk of BoP crisis, healthy domestic financial sector and relatively small local corporate external re-financing risks.

6 – 12 Month Outlook: An EM outperformer

The U.S. growth and global credit/liquidity outlook should dominate USD/MXN, exerting upward pressure on the latter as export, financial (portfolio and FDI) and FWR inflows slow more pronouncedly than observed thus far. Sustained USD strength, 2009-H1 Banxico rate cuts and downward pressure on oil prices on the back of weaker global growth will hurt MXN but it should remain a low-vol EM outperformer given the country’s investment grade status and strong fundamentals.