Wells Fargo Blames Central Bank for Mexico Peso’s 2016 Swoon

Updated on
  • Policy makers boosted key interest rate by a record to 4.25%
  • Peso is suffering second-biggest drop among major currencies

Mexico’s central bank actually may be to blame for the peso’s slide this year.

Nicholas Bennenbroek, the head of currency strategy at Wells Fargo & Co. in New York, argues that policy makers’ bid to bolster the currency by boosting interest rates has backfired.

While the central bank has lifted borrowing costs by a record 1 percentage point this year to 4.25 percent, the peso is posting the second-biggest loss among the world’s major currencies. Bennenbroek says the unanticipated surge in borrowing costs has spooked foreign investors in Mexico’s shortest-term bonds instead of luring them to the country so they can profit from higher yields. Overseas investors have slashed their holdings of Mexican bills by 57 percent this year, resulting in outflows that have deepened the peso’s slide. 

“The key thing about the Mexican rate hikes is that they’ve been quite sharp and unexpected,” Bennenbroek said. “It’s surprising how poorly Mexico has performed. Usually you’d say higher interest rates were good for the peso. The only question is were the rate hikes so sudden and unexpected that it creates a bit of risk that the Banco de Mexico will keep raising?” 

Mexico’s currency has dropped 10 percent against the dollar this year, eroding returns for bond investors. The country’s notes have lost investors 3.5 percent in dollar terms, compared with an average return of 13.5 percent for Latin American local debt.

On Tuesday, the currency posted the biggest loss in emerging markets, slumping 1.7 percent to 19.1362 per dollar as of 10:41 a.m. in New York. Swings have increased in developing-nation currencies as investors weigh the outlook for global economic growth and prospects for further stimulus from central banks, with 10-day historical volatility on the MSCI Emerging Markets Currency Index almost quadrupling since the end of July.

As one of the most-traded currencies, the peso tends to rise and fall more than its peers during periods of upheaval, and the cost of options to protect against swings in the currency has surged. Three-month implied volatility for the peso, a measure of the cost of options, jumped 1.87 percentage point in a week to 15.81 percent, the highest since June.

That peso’s underperformance may worsen because there are more rate increases in the offing. The central bank will lift benchmark borrowing costs by another 0.25 percentage point by year-end, according to analysts surveyed by Bloomberg.