Down and Up Again

The old story of the Mexican peso’s volatility ends with the record devaluation in late 2016 and early 2017 as the first half of 2017 brought a different tale of stability and growth thanks to institutional confidence in the Mexican market. It remains to be seen what the future brings, but initial signs are positive that the peso can remain one of the top emerging-market currencies in the globe.

Classified as an emerging-market currency, the peso is highly dependent on the global economic climate and more specifically economic conditions in the US. Unsurprisingly then, the US election of 2016 had a significant impact on the peso’s valuation. For months, the peso served as a bellwether of investor confidence about the election and the future of economic flows between the two countries. As Donald Trump rose in the polls, the peso fell correspondingly, due to concern over what his protectionist trade policy would do for the Mexican economy. Trump vowed to construct a wall on the Mexican border, renegotiate NAFTA, and dramatically reshape trade flows between the two countries. As the election dragged on, the peso continued to lose value: from January 2016 through the end of October, the peso fell more than 10%, though this number hardly tells the full story of the currency’s volatility.
In the midst of this uncertain climate, Mexico’s Central Bank took aggressive action to check the peso’s devaluation. The Banco de Mexico raised its benchmark interest rate from 3.75% to 4.25% in June 2016, and then raised it again to 4.75% in September. At its highest rate since the global economic crisis of 2009, the mark reflected the bank’s desire to prevent inflation.
Following the election of President Trump. the peso dropped by 9% overnight to reach an all-time low of more than MXN20 to the dollar. The slide continued into early 2017, with the peso accelerating to a new low of MXN22.03 per USD after Trump’s speech that threatened US auto companies with high taxes on vehicles manufactured in Mexico. Mexico’s central bank took further action after the election, raising the interest rate to 5.25% in November, then to 5.75% in December and 6.25% in February. The central bank also sold USD2 billion in reserves in early January 2016 to further support the peso and stave off inflation, which had accelerated by 4.72% YoY as of January 2017, well above the central bank’s target rate of 3%.
No single entity can take full credit for the peso’s ensuing resurgence, but the central bank’s aggressive action has been widely praised. June 2017 saw the peso hit a 14-month high of MXN17.8 to the dollar after six months of steady performance that has seen it gain 15.3% against the dollar. Analysts, almost uniformly pessimistic about the peso eight months earlier, now project the currency to continue to strengthen; an early July Goldman Sachs report projected the peso to continue to strengthen to MXN17 per dollar by July 2018.
Though inflation rose to 6.3% in June 2017, financial leaders noted that economic indicators all pointed to inflation peaking soon and then converging on the bank’s 3% target. Mexico has also benefited from a robust export economy that has formed new ties with Asian nations, giving investors confidence that any changes in US policy will not have outsize effects.
Trump’s threats of new tariffs and protectionist policies have taken a backseat to other initiatives, and as a result, investors expect any potential renegotiation of NAFTA to be less destabilizing to the Mexican economy than originally feared. The fact remains that Mexico’s currency is greatly affected by the political and economic situation in the US. Still, Mexico’s prudent reaction to the political uncertainty and resulting currency depreciation of 2016 has given global markets confidence that they are more than able to deal with whatever the future may hold.