Mexican Peso's Surprising Drop Spurs Speculation Banxico to Act

  • Currency has tumbled 5.9% this year, worst in Latin America
  • One-year implied volatility climbs to highest since October

The tumble in Mexico’s peso this year as volatility surges is spurring speculation that the central bank will step up efforts to support the currency.

Policy makers will probably reintroduce daily auctions of $200 million at no minimum price at the end of this month, a policy in place from August through November, according to Citigroup Inc. Grupo Financiero Banorte SA expects the size of auctions when the peso falls at least 1.5 percent to swell to $500 million from $200 million. Rabobank predicts sustained volatility will spur bigger increases to the central bank’s benchmark rate.

Mexico’s peso, which analysts had forecast would gain 1.2 percent in the first quarter, has instead been the worst performing major currency in Latin America this year, sinking 5.9 percent as investors turn increasingly bearish on the prospects for developing nations amid concern the global economy is slowing. One-year implied volatility, a measure of the swings expected over the next 12 months in the world’s most traded emerging-market currency, surged to the highest in more than three months Tuesday.

“In the past, we expected to see Mexico’s fundamentals begin to shine through, but in 2016 we are of the view that this could prove elusive again,” Christian Lawrence, a currency strategist at Rabobank, said Tuesday in a note to clients.

Mexico’s peso avoided the worst of the rout in Latin American currencies last year, falling just 14 percent as Colombia’s peso tumbled 25 percent and Brazil’s real lost a third of its value. Investors saw Mexico better positioned to withstand the rout in commodities prices because its economy is more tied to manufacturing and consumer demand from the U.S., the destination for 80 percent of its exports.

This year has been different, with the peso the second-worst performing major currency, as investors use Mexico’s highly liquid peso as a proxy for global emerging markets. Investors are also concerned that the outlook for higher interest rates in the U.S. will lessen Mexico’s appeal for bondholders chasing the country’s steeper yields. The currency slipped 0.4 percent Tuesday to 18.2831 per dollar as of 2:40 p.m. in New York after touching a record-low 18.2987.

Lawrence said that if volatility continues in the peso, the central bank is likely to raise interest rates beyond the two increases to 3.75 percent that he had forecast.

Since November, the central bank has been selling $200 million on days the peso weakens at least 1 percent and an additional $200 million if the drop is more than 1.5 percent. The policies to support the peso have contributed to an erosion in the country’s foreign reserves, which are near a one-year low at about $175 billion.

If volatility in the peso doesn’t subside, the bank is likely to begin to offer auctions of $200 a day without a set minimum price when it changes policy at the end of this year, Citigroup foreign exchange analyst Dirk Willer wrote in a Jan. 15 note.

Juan Carlos Alderete, a strategist at Grupo Financiero Banorte SA in Mexico City, said that while the structure of the dollar auctions are likely to stay the same, the bank is likely to increase the size of sales triggered by a 1.5 percent decline to $500 million.

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