(Bloomberg)—The carry trade The relatively attractive volatility-adjusted Mexican peso means the currency is once again being favored after a brief period of turmoil in late 2021.
The carry trade is a strategy that is generally used with currencies that consists of borrowing money in a currency with low interest rates, and then investing that money in another currency with a higher interest rate. A perfect example at this time would be to request a loan in dollars or euros and then change them to Mexican pesos.
The peso has outperformed all 24 emerging-market currencies tracked by Bloomberg since late November, when President Andrés Manuel López Obrador’s appointment of a relatively little-known official as governor of Banxico sent markets into a tailspin. On Thursday, the currency hit a two-month high, ignoring the rise in US Treasury yields this year.
This could be just the start of a strong weight losing streak., as investors are attracted by Mexico’s rising interest rates, an election-free calendar and the country’s close ties to the US economy. This is even more compelling in a region where political uncertainty, coupled with a turbulent global market, is increasing implied volatility, making riskier currencies more expensive for traders to hold.
Although Mexico’s key rate of 5.5% is very low compared to Brazil’s 9.25%, the single-digit implied volatility of the peso is well below that of the Brazilian real, which is above 14%. It is also much lower than that of the Russian ruble and the South African rand, giving the peso one of the best risk-reward profiles in the developing world.
“The Mexican peso continues to be one of the most attractive currencies in emerging markets”said Mauro Roca, managing director of emerging markets at TCW Group Inc. in Los Angeles. “It has carry, little political buzz, and remains a play on American exceptionalism, even as the domestic recovery falters in Mexico.”
The peso’s volatility-adjusted carry trade, which is calculated by dividing the implied one-month yield by the implied volatility over the same period, has improved nearly 50% in the last six months and is now hovering around levels last seen at the end of February 2020.
You may also like:
Mexico’s central bank, known as Banxico, raised its policy rate by 125 basis points last year as inflation accelerated to the fastest pace in two decades. Economists forecast that the rate will reach at least 6.50% by the end of 2022, according to the latest Cibanamex survey.
Swap traders, for their part, anticipate a more aggressive tightening, with an increase of more than 200 basis points, which is helping the peso to weather the storm caused by the Federal Reserve’s tightening expectations. The two-year spread between Mexican and US swap rates have risen some 100 basis points in the last three months, adding to the attractiveness of the Mexican currency.
“Risks are clearly tilted to the upside” for the benchmark rate, Citibanamex analysts led by chief economist Adrián de la Garza wrote in a note. The bank currently projects 125 basis points in rate hikes this year.
The next meeting of Banxico, to be held on February 10, will be led by Victoria Rodríguez Ceja, and investors will examine the speeches of those responsible for monetary policy to determine if the increase of 50 basis points last month was a fact punctual. The appointment of Rodríguez, who has little experience in monetary policy and has made few comments on inflation, rattled markets and pushed the peso to hit a 2021 low of 22.155 per dollar in November.
Sacha Tihanyi, head of emerging markets strategy at TD Securities in Toronto, said there is a chance the central bank won’t make the rate hikes traders are hoping for, weighing on the peso.
“Will Banxico disappoint market expectations? The risks are not zero, especially considering where the markets have priced in rates,” said Tihanyi, who recently reopened a recommendation to short the Mexican currency.
Any sign of a dovish stance on Rodriguez’s first rate decision would be an open invitation to peso bears. Still, some analysts say give him the benefit of the doubt.
“I remain optimistic,” said Daniel Tenengauzer, chief market strategist for New York-based Bank of New York Mellon. “I don’t think the market is still comfortable with a new governor who will, in fact, deliver another 50 basis points.”
In addition to rising rates, another potential boost for the peso this year comes from portfolio inflows. Investors remain bullish on Mexican stocks after posting their best year since 2009, with Bank of America recommending an overweight position.
At the same time, foreign holdings of local currency government bonds, known as MBonos, are increasing. The 20-day moving average of MBonos inflows hit 2.52 billion pesos ($124 million) on December 22, a few days after the central bank announced a 50 basis point rate hike.
You may also be interested in | VIDEO: Bitcoin’s explosive rallies and spectacular falls
Mexican Peso Regains Investor Favoritism Amid Global Yield Surge
©2022 Bloomberg LP