FxWirePro: Mexican macros (BoP, Fiscal deterioration and Political uncertainty) likely to keep peso vulnerable, IV skews and valuations substantiate

Mexican peso (MXN) could be under pressure by the balance of payments dynamics in the medium-run. While the business sentiment continues to be near its weakest levels, whereas consumer sentiment remains resilient, backed by president AMLO’s strong popularity and minimum wage increases.

While this bodes once again poorly for investment, such dynamics could also have a negative impact on Mexico’s trade balance: manufacturing exports could stay weak, particularly as manufacturing PMI weakened once more in February (last) and new orders dropped.

The current valuations seem rich while foreign positions seem already short USD. MXN continues to trade on the rich-side relative to our BEER FV models, based on productivity and policy rate differentials, terms of trade and basic balance. 

At the same time, in the near-term, technicals continue to bode poorly for MXN, particularly given heavy positions: long MXN positions via IMM contracts are already at their multi-year highs according to CFTC data.

JP Morgan team expects 2019 GDP growth at 1.5% and limited monetary policy rate changes this year (they expect Banxico to remain on hold through 2019), we suspect that portfolio inflows are likely to moderate ahead, limiting MXN’s main source of support this year. 

While the weak growth, domestic political risks and growing concerns about the financial situation of the state-owned energy supplier and thus about a possible deterioration in public finances are likely to weigh on the peso in the coming months. But we do not expect an excessive depreciation as long as there is no external shock. Additionally, the negotiated USMCA deal should be ratified by the respective parliaments this year, which would remove a major uncertainty factor from last year. 

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 (refer above nutshell showing IV skews). 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, spot reference: 19.2050 levels. Courtesy: JPM, Sentry & Tradingview.com

Currency Strength Index: FxWirePro's hourly USD spot index was at -26 (mildly bearish) while articulating at (12:38 GMT).

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