FxWirePro: Square-off and reshuffle MXN shorts via optionality

Speculations over Banxico’s rate cut are becoming increasingly louder already this year. Weak growth and, above all, the decline in inflation have fuelled such discussions. 

In January and February, seasonally adjusted consumer prices were unchanged compared to the previous month. The sharp rise in the minimum wage in December and the shortage of fuel in January had no negative effect on inflation. At 3.9% in February compared with the previous year, inflation was within the central bank's target corridor (2-4%) for the first time since the end of 2016.

Currently, the FX market lacks the impetus to trade the Mexican peso in one direction or the other. As a result, USDMXN has been moving more or less sideways since the beginning of the year.

We move UW MXN in our GBI-EM model portfolio, as political uncertainty, long MXN positions, unattractive valuations, and foreign outflows suggest the MXN could underperform relative to other Latin America currencies. Specifically, MXN continues to trade on the rich-side relative to our BEER FV models, while relative strength indices point towards MXN weakness near-term as it has neared a level where it sold off in the past. 

Long MXN positions have also increased steadily, with IMM data showing peso longs at multi-year highs.

At the same time, MBonos and Cetes unwinds by foreign investors suggest reduced support for MXN: foreigners reduced their Cetes (t-bills) holdings by MXN 24bn (USD 1.8bn) since February 27thand reduced their Mbono exposures by MXN 14bn in the past four weeks ending on April 10th according to Treasury data.

Finally, valuations for MXN look unattractive relative to Latam peers, and underprices some local risks in our view.

We, therefore, roll our MXN option: we close our previous MXN put which expired today out-of-the-money, and purchase an MXN 3m ATMF put with RKO = 20.20 to cheapen the options structure to 50bps. The main risk of this trade is to lose the premium, and we choose to be somewhat neutral vol overall since we have no specific catalyst in mind. Put spreads would be another more conservative alternative. Courtesy: JPM

Currency Strength Index: FxWirePro's hourly USD spot index has bearish index is creeping at -100 (highly bearish) while articulating (at 11:43 GMT). 

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