FxWirePro: Mexican Peso Likely To Be Vulnerable On Baxico’s Monetary Policy Cycle – Bid 3M Skews And Hedge USD/MXN Upside Risks

At its meeting today, the Mexican central bank (Banxico) is likely to cut its key interest rate again by 25 bp. There is hardly any doubt about that. Inflation stayed around target in the past months and the economy has been weakening for some time now. However, like most market participants, we consider a faster rate cut unlikely. In the past, the central bank has always pointed out that the development of core inflation has not been entirely in line with its wishes. As it rose again slightly in January, the central bank will stick to its cautious approach and cut the key rate again by a small step. For the MXN, today's interest rate meeting is probably a non-event. So far, the interest rate cuts have not been able to harm the MXN. The still high interest rate level (currently still at 7.25%) makes the peso attractive. However, the Mexican central bank is likely to continue its cycle of interest rate cuts for a while, so the peso is becoming less attractive. We therefore expect the peso to weaken against the USD in the course of the year.

OTC Updates and Options Strategies: 

Please be noted that the positively skewed IVs of USDMXN of 3m tenors have been indicating upside risks, while IV remains on lower side and it is perceived to be conducive for options writers.

It is analysed that earning theta without taking left tail risk via high beta ratio call spreads. Such structures are covered to a fair extent against spikes of high beta volatility given the long risk-reversal sensitivity embedded in the structure. 

Considering the current MXN skew setup and the receding risks for MXN spot we are open to taking the gamma risk in order to more efficiently reap the extra OTM vs ATM premium on MXN put side. 1*1.5 MXN ratio put vol spreads have shown strong and almost equivalent systematic returns for USDMXN and EURMXN over last few years.

3M USDMXN ATM/25D 1*1.5 vol ratio call spread vs 18.49/19.65 indicative. Courtesy: Sentry & JPM

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