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Real effective exchange rate shows excessive peso weakness
Strategists raise forecasts for the peso as Nafta threat fades
Don’t let the Mexican currency’s rally this year turn you off. Strategists from Morgan Stanley to BNP Paribas SA say it’s a great bet.
The peso has risen 15 percent this year to trade at 18.0759 per U.S. dollar on Thursday on speculation the U.S. is less likely to pursue a damaging renegotiation of the North American Free Trade Agreement. Wall Street banks, and even Mexico’s central bank Governor Agustin Carstens, insist the currency’s still cheap.
Some analysts have boosted their forecasts for the peso to levels last seen before Donald Trump was elected after campaigning on a pledge to protect American workers by cracking down on Mexican imports. Since March 31, economists surveyed by Bloomberg have raised their first-quarter 2018 estimates by the most of any Latin American currency, according to data compiled by Bloomberg.
"Our favored currencies are those that still have cheap valuations that can attract inflows and aid external rebalancing, and are supported by good or improving growth, " Morgan Stanley analysts led by Hans-Guenter Redeker wrote earlier this month. "Positive headlines about the direction and the speed of the changes should bolster the currency."
JPMorgan Chase & Co. upgraded its peso forecast this week to 18.5 per dollar at the end of the year, compared with a previous prediction of 19.8. Morgan Stanley now sees it gaining 3.7 percent to end the year at 17.5, an improvement from an earlier forecast of 20.3.
The currency’s real effective exchange rate is another bullish signal. The measure of the peso’s value versus a basket of peers reached a 17-year low in January, and while it’s recovered since then, the gap remains wide when compared with its five-year moving average. The last time it was trading at "fair value," or at purchasing power parity with its commercial peers, was in late 2014.
Not everyone is so optimistic. The peso’s most accurate forecaster for the first quarter, according to a Bloomberg ranking, said currencies can be undervalued or overvalued for years without being bound for a correction. Scott Petruska, a senior adviser at SVB Financial Group, says the peso will weaken to 18.8 per dollar by year-end.
“Volatility is going to pick up and as it does, you get people pulling away from higher-risk investments, whether it is emerging-market assets, carry trades," Petruska said. "The peso has kind of run most of its course.”
But the real effective exchange rate along with Mexico’s appeal as a carry-trade destination are just two of a handful of key factors that Gabriel Gersztein, an analyst at BNP Paribas, sees as positive. He forecasts the peso ending the year at 18 per dollar. In a carry trade, traders borrow in countries with low interest rates and invest where yields are higher.
"When you adjust the carry that the Mexican peso offers by the credit rating, or risk, the Mexican peso is probably one of the most attractive currencies in the world right now," he said from Sao Paulo. "And in terms of external vulnerabilities, the worst is for sure over."