FxWirePro: USD/MXN calendar spreads to encompass not only NAFTA’s optimism and pessimism but also election risks

The 6th round of the negotiations between Mexico, Canada, and the US about a possible realignment of NAFTA would begin today in Montreal. From the recent past, the lingering optimism about the prolonged existence of the free trade agreement constantly zigzagged with pessimism.

USDMXN exchange rate levels were always the best indication of what sentiment currently prevailed. At present optimism seems to have the upper hand, although it may have been dampened somewhat by the new US trade decisions.

Should the optimism turn out to be unjustified over the coming days, USDMXN could quickly climb towards 19 again. The parties still have to reach a compromise on important issues such as the rule of origin in the automotive industry, the so-called “sunset clause“, which states that the agreement automatically comes to an end every 5 years unless all parties explicitly agree on its continuation, as well as US recognition of arbitration tribunals.

It remains a real risk that the US could end the negotiations and thus the agreement. On the other hand: should the negotiations make clear progress MXN might be able to recover some ground. So it remains true that at present everything depends on NAFTA.

Stay UW MXN and add longs in 1m/5m calendar spreads (1m 18.50 MXN call and 5m 20.0 MXN put for 270bps). MXN outperformance can go in our view, as the expectation of the market for the balance of risks around NAFTA ahead of the Jan 24-28 negotiation round has improved.

However, this outperformance could be short-lived; we maintain that the medium-term outlook for MXN is negative as investors are likely to shift their attention from NAFTA to the election cycle as well.