FxWirePro: Spotlight on Banxico – Technicals and Options Markets Still Signal Vulnerable Mexican Peso

The Mexican central bank (Banxico) should again leave its key rate unchanged at 8.25% at tonight’s meeting. Due to weak growth and lower inflation rates, some expect Banxico to cut interest rates this year. But it is much too early today.

The Banxico kept its benchmark interest rate at a 10-year high of 8.25% on 28 March 2019, as widely expected. The decision was unanimous. Policymakers noted that global growth prospects have deteriorated and that domestic prices declined recently, favored by non-core transitory factors.

Due to domestic political uncertainty, which has increased significantly since President Andres Manuel Lopez Obrador took office in December, external uncertainties due to the trade conflict between China and the US Banxico is likely to keep its cautious stance. The peso remains susceptible to increased risk aversion. A weaker peso could result in higher inflation, evaporating the central bank's hopes that inflation will finally return to the 3% target. Banxico will therefore probably continue to point out the upside risks for inflation today and thus reject an interest rate cut in the near future. This is good news for the peso, but domestic and foreign policy remains a key driver. 

Technically, USDMXN major uptrend remains intact despite some minor corrections (refer above technical chart). We maintain MXN projections of 20.25 for end- 2019 and our long USD recommendations in options. The peso’s high carry is likely the reason for MXN’s outperformance this year among EMFX peers. Yet, extended MXN longs positions, BoP weakness, political uncertainty and some fiscal deterioration in our view make MXN more likely to weaken for the rest of the year.

Of late, MXN seemed to be extending recovery threatening upper bound of the recent range.

But please be noted that the 3m USDMXN implied volatility skews signal continued upside risks. The previous massive sell-off of Mexican peso caused a vol surface dislocation, nudging skews to the highest since the 2016 US Presidential elections. Delta hedged 1*1.5 ratio call spreads exploit the dislocation while also having historically offered a superb performance. +1Y/-3M calendars of risk reversals take advantage of the lagging back-end vs front-end implied skews. Courtesy: Commerzbank & Sentry

Currency Strength Index: FxWirePro's hourly USD spot index was at 74 (bullish) while articulating at (14:22 GMT).

For more details on the index, please refer below weblink: http://www.fxwirepro.com/currencyindex