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Mexican central bank (Banxico) yesterday raised its key rate by 25bp to 7.25%, one central bank member has even voted in favour of a 50bp hike which has been slightly exaggerating. The policy statement underscored the complex macroeconomic context and the recent inflationary uptick. Owing to the distinctive effects (rise in energy prices) inflation has risen to over 6% this year and has remained at this high level very stubbornly for some months now.
In its statement the central bank also mentioned several risks that might lead to a weaker peso. The first one amongst these are the NAFTA negotiations but a further tightening of US monetary policy might also provide pressure.
We reckon that the MXN to stabilize around 18.80 on domestic and NAFTA considerations. We mentioned MXN hedges at these levels were no longer necessary, yet admittedly further high-carry FX weakness will continue to spill-over into MXN as the typical hedging currency for the asset class.
Consequently, subsidized gamma longs via +2M/-6M vega-neutral calendar spreads that fade this curve steepness are good value in MXN and IDR.
We had also also flagged MXN and TRY as the two currencies where curve-based gamma longs offered good value; both delivering solid returns is the recent times has been the evidence that EURMXN still remains a favored gamma buy in vega-neutral calendar format.
MXN, like other petro-currencies, has decoupled from the surge in oil prices and responded more forcefully to idiosyncratic domestic and international (NAFTA) political factors, and is potentially susceptible to sharp mean-reversion stronger, especially after official FX intervention appears to have been successful in stemming runaway peso weakness.
Additionally, while it matters much less for short-tenor options, it does not hurt that EURMXN implied vols look historically underpriced in relation to the carry in forward points: the above chart shows that the carry/vol ratio of EURMXN straddles – defined as at expiry payout of the straddle assuming unchanged spot/current option premium – has spiked to levels last seen in the go-go pre-Lehman years, hence there is even a case for playing for near-term reversal of recent peso weakness via options.
