The Mexican peso outperformed in the first month of 2020, being one of the only four currencies in the EM space with positive spot returns against the dollar.
The currency shrugged off the effects of coronavirus unlike most of the asset class, despite the Mexbol index sliding over 2% from the highest point of the month.
The single most convincing explanation for the peso uptrend is based on its high relative carry, which ranked third among EM in January, after the ARS and IDR.
In addition, the peso has been strongly supported by the ratification of the revised USMCA trade deal with Mexico´s main trade partners as it improves overall business sentiment.
Chart 1: The dynamics seen in the USDMXN rate over the last semester provide a solid bullish picture of the currency, as each new peak has sat at a lower level than the previous one
The relatively calmer global trade scenario, along with mildly better domestic growth prospects in 2020, has also added to the overall MXN outlook.
However, looking ahead, worsening macro macroeconomic fundamentals and fading carry appeal are set to remove fuel from the peso.
Several institutions have downgraded GDP growth forecasts for 2020 after the dismal economic performance in 2019…
Based on flash estimates, the economy saw a 0.1% contraction last year, a sharp decline from the last 4-year average of 2.6% YoY and the first economic slump in a decade. The 1.7% drop in the manufacturing sector was the main drag of the overall outcome, offsetting the mild expansion in both the primary and services sector, of 1.9% and 0.5% respectively.
Much of the economic fallout could be attributed to the AMLO effect, with investment demand particularly affected by uncertainty in the political direction of the new administration.
While negative economic gaps have been common in the first years of new administrations, AMLO’s underperformance has been the largest since the Ernesto Zedillo´s start in 1995, during the Tequila Crisis.
Growth projections for 2020 has been revised down both by the World Bank and the IMF to 1.2% and 1%, from 2% and 1.3% respectively. Consensus from economists surveyed by Mexico´s Central Bank signals a growth forecast below 1% this year.
At this juncture, there is little argument for Banxico to change its accommodative policy stance. The political environment within the country still poses risks to businesses, however, investors’ confidence has been supported by the new USMCA trade agreement and a sound fiscal stance pursued by the administration.
Inflationary dynamics, on the other hand, play in favor of a looser monetary position. Headline CPI inflation sat below the 3% annual target set by Banxico by the end of 2019, after retreating from 6.8% over the last two years.
While some of this effort has been a consequence of a sliding economy, this result also proves Banxico’s resolution in delivering on its mandate.
With over 150 basis points of monetary space until the neutral interest rate is reached, Banxico is widely expected to ease its policy tools throughout the year by at least 100 basis points more. Inflation resilience within Banxico’s target range will be pivotal in the expected policy path.
Updated figures for annual CPI inflation will be released next week on Friday 7th, ahead of the first 2020 Banxico meeting the week after.
Author: Olivia Alvarez Mendez, Market Analyst at Monex Europe in Spain.