Mexico Update: Peso Poised to Recover

The Mexican peso has been among the worst performing of the more actively trading currencies against the dollar since the start of the month. Yet in the coming weeks, if a more stable tone in the markets emerge, the peso is a likely candidate for out-performance.

There are two main considerations for this optimism. First, the slide in the peso of nearly 10% at its extreme has seen the over hang of long positions scaled back considerably. As recently as mid-July there were nearly 100k net long speculative contracts. In early August, there were still 88.5k net speculative longs. In the week through last Tuesday, August 9th,those net speculative longs were slashed by more than half to 41.3k, this is the lowest since last September.

Second, the peso enjoys a remarkably high correlation with the S&P 500. On a 30-day rolling basis, using percentage change, the peso and the S&P 500 is more than 90% correlated. Ironically a more stable tone in equities after last week's hellacious moves could see the peso recover against the dollar, even if the correlation weakens from its extreme readings.

As one would expect, given the economic and financial linkages with the US, the weaker demand the US has experienced this year has translated into softer Mexican data. Although rate hike expectations by Banxico have been reversed, we think the market is getting ahead of itself by pricing in a near-term cut.

This also supports our more optimistic near-term outlook for the peso, and also suggests why investors should be prepared for additional curve flattening with the front end yields rising and the longer end coming under some pressure.

Initial support for the dollar is seen near MXN12.20 and a break could see MXN12.00-MXN12.05. The case for even a stronger recovery might require greater stability in the global capital markets and perhaps better US economic data.