Mexican Peso Traders Pile Into Hedges

Updated on
  • Implied volatility rising, especially in nine-month contracts
  • Lopez Obrador seen gaining ground ahead of presidential vote

Growing speculation that a populist candidate stands a good chance to become Mexico’s next president is sending traders to the options market for protection against a selloff.

The nation’s currency, the top performer for the first half of the year, has been among the world’s worst since mid-September as talks to renegotiate the North American Free Trade Agreement drag on and the U.S. and Mexico threaten to quit the deal. At the same time, political developments are helping solidify Andres Manuel Lopez Obrador’s frontrunner status before the July 2018 election, worrying investors who see him as a threat to the country’s economy.

All this has traders repricing risk, sending implied volatility on the currency soaring as the cost increases to hedge against losses. The biggest jump in expected price swings is seen in the nine-month contracts -- those that come due right around the time Mexicans will vote for their next president.

“That certainly reflects markets looking ahead to next year’s election and starting to price in some risk around that event,” said Erik Nelson, a currency strategist at Wells Fargo & Co. in New York. “The peso tends to show heightened volatility and some degree of weakness in the weeks and months leading into” presidential ballots, he said.

The Mexican peso posted the worst slide among emerging-market currencies last week, reaching the lowest level in four months, as the country’s former first lady Margarita Zavala left the PAN party, generally seen as the most business-friendly, and said she will register as an independent candidate. The move could split voters aligned against Lopez Obrador, potentially boosting his chances of winning the presidency. In some recent surveys, Lopez Obrador and PAN’s Ricardo Anaya were tied on voting intentions. 

Lopez Obrador, 63, has opposed efforts to open the economy, especially those related to loosening labor laws and easing the state monopoly on oil production. He has also raised red flags for investors because of his promises to boost social-welfare spending. Traditionally most popular among lower-income Mexicans, he has also gained new fans for his strident opposition to U.S. President Donald Trump’s anti-Mexican rhetoric.

“Populists can be very bad for the economy," said Paul McNamara, who oversees a $8.2 billion emerging-market local debt fund as a money manager at GAM UK Ltd. in London. He is still long Mexican local bonds amid his bullish view for emerging-market currencies, but says risks to the country mostly come from the U.S., not only from Nafta negotiations but also the potential for provocative comments from Trump to boost Mexican populists.

Analysts at Morgan Stanley, long-time bulls on Mexican bonds and the currency, switched to a neutral call this week, saying the country’s assets are at risk from the Nafta negotiations and the presidential vote. The Mexican peso gained 0.5 percent to 18.7393 as of 1:07 p.m. in New York.

“It was just a matter of time before markets started pricing in risks regarding the election,” said Gustavo Rangel, the chief economist for Latin America at ING Financial Markets LLC and one of the top forecasters for the region’s currencies, according to Bloomberg rankings. He predicts the peso will slide to 20 per dollar before the vote.

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