Mexico Battles Emerging-Market Bears With Surprise Peso Defense

  • Rate increase and new intervention program seek to stem slide
  • Peso is world's worst-performing major currency this year

The Mexican government’s unprecedented steps to protect the peso are off to a good start.

The currency posted its biggest rally in five years Wednesday after officials said they will increase the benchmark interest rate, reconfigure an intervention program to contain volatility and reduce government spending. It advanced another 0.5 percent on Thursday. The new measures came after the peso plunged 8.9 percent to start the year, the worst performance among major currencies, and was down 31 percent over the past 18 months as investors sold off emerging-market assets.

Mexico finds itself in a peculiar situation: While its economy is in relatively good shape -- with gross domestic product growth forecast to accelerate for a fourth straight year, a booming manufacturing industry led by auto production and inflation near a record low -- its currency has been battered more than most. A plunge in oil prices and concern the global economy is slowing have had an outsize effect because the currency’s high liquidity and low borrowing cost make it a favorite for traders seeking to hedge risk.

“The peso for some reason has been depreciating more than other emerging-market currencies while the fundamentals have stayed reasonably solid,” said Gerardo Rodriguez, a New York-based money manager at BlackRock Inc. and a former deputy finance minister for Mexico. “Measures like these aren’t announced everyday. They’re what one would expect in this environment.”

Oil’s Swoon

Officials raised benchmark borrowing costs 0.5 percentage point to 3.75 percent, marking what Barclays Plc said was the first time that the central bank has increased rates at a surprise meeting. Central bank Governor Agustin Carstens and Finance Minister Luis Videgaray also said the government and state oil company will reduce their spending plans this year by the equivalent of 0.7 percent of GDP to cope with lower oil prices. Crude sales provide about a fifth of the Mexican government’s revenue.

Raising interest rates may help the peso trade more in line with economic fundamentals because it will no longer be as cheap to borrow the currency for hedging purposes, according to Nomura Holdings Inc. and Credit Suisse Group AG.

“The arsenal that Mexico deployed today will reduce investors’ incentives to position against the Mexican peso,” Alonso Cervera, Credit Suisse’s chief economist for Latin America, said in a note to clients. “The cost of shorting the currency has just gone up by 50 bps and there is the possibility of a surprise intervention any day of the week."

Mexico Growth

Mexico is among oil-producing nations across the world that are facing pressure from low crude prices. On Wednesday, Standard & Poor’s cut its credit ratings on Saudi Arabia, Oman, Bahrain and Kazakhstan, citing worsening growth outlooks due to the oil rout. Last week, world equities descended into a bear market as the drop in commodities prices and concern about global growth sent investors fleeing from all but the safest assets.

Still, Mexico is forecast to grow 2.8 percent this year, according to the median estimate of analysts surveyed by Bloomberg. Latin America as a whole is due to shrink 0.5 percent while Brazil is heading for its worst recession in more than a century.

Officials have expressed growing concern in recent weeks that the drop in the currency would fuel inflation as import costs increased. Since December 2014, the central bank had been selling as much as $400 million in daily auctions, interventions that Morgan Stanley and other strategists said were too predictable and too small to counter the growing bearish sentiment. Under the plan announced Wednesday, the central bank will instead sell dollars directly to banks whenever volatility in the currency becomes excessive.

The peso, which gained 2.8 percent Wednesday to 18.3653 per dollar, touched a record low 19.448 per dollar earlier this month. Mexico’s tender is the world’s most-traded emerging-market currency, and trades can take place 24 hours a day, five days a week.

“To have the currency depreciating above 19 pesos per dollar and with no signs of stopping is scary," said Benito Berber, a strategist at Nomura in New York. “Proxy hedging was having a huge impact, more than it should."

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