FxWirePro: Mexican peso staged for bearish rout, Bid OTM calls as skews signal USD/MXN bullish risks

We devise our MXN projections at 20.50 by end-2019 and accordingly, advocate ATMF USD calls. The lure of carry has made the FX market complacent, with several negative developments - including the gasoline shortages - seemingly not priced into the FX market, which has outperformed all other asset classes YTD and returned to pre-referendum (November) levels. 

With the expected growth of 1.9 and 2%, the economic outlook for 2019 and 2020 is below the 2.6% average of the past five years. In 2018 the business cycle was sustained primarily by private consumption. Investment weakness is now less pronounced but has not been overcome. The central bank has responded with determination to inflationary drivers such as the peso devaluation and energy price increases, raising the policy rate by a total of 525 basis points since November 2015. 

Technically, USDMXN forms shooting star at 19.90 that plummets prices below EMAs, on the contrary, bullish engulfing popped-up at 20.3405 levels to counter previous bearish swings, bulls now test supports at 21-EMAs and currently trading at 19.3400 levels with bullish sentiments.

OTC FX updates: 

Please be noted that the 1y skews signal upside risks of this pair, hedgers’ bids up to OTM strikes up to 20.60 levels.

With the above in mind, we take the opportunity to analyze what generally works on the MXN vol surface, on a back-tested basis, and from a pure vol standpoint. The above nutshell explains a variety of structures for 3M maturities. For instance, selling RRs (delta-hedged) works orders of magnitude better than selling ATM vol. Better yet, 1*1.5 ratio USDMXN call spreads (delta-hedged) have been notably a high Sharpe Ratio (1.66) trade to hold over the years. Being long ATM vs. short OTM calls at near vega neutral notionals, the 1*1.5 ratio call spread structure is also well positioned to be selling topside OTM vols, which now are priced heftily after the latest vol explosion. 

The peso sell-off triggered a vol surface dislocation, pushing gamma vols to 15.3 handle, the highest since June, and an even quicker reaction of front-end skews, reaching the highest since the 2016 US Presidential elections. The back of the vol curve is lagging the move, with 12M / 3M 25D risk reversals vol ratio at a multi-month low. Courtesy: Sentrix & JPM

Currency Strength Index: FxWirePro's hourly USD spot index is flashing at -14 (which is mildly bearish), while articulating at (13:56 GMT). 

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