Dollar vs. Peso: Stabilizing

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Includes: FXM, UDN, UUP
by: Marc Chandler
Earlier this week the US dollar rallied strongly against the Mexican peso, nearing MXN13.37 and was even near MXN13.36 yesterday before staging an outside down day (traded on both sides on Wed range and then the dollar finished below the Wed low). However, the pressure on the greenback appears to be abating just below the MXN13.00 level. That said, the boom end of the 5-6 month range comes in near MXN12.80.
In addition to the larger macro picture, including a strong appetite for emerging market exposure, the most immediate issue is debate over fiscal policy. S&P and Fitch have Mexico on negative outlook due to the deterioration of its fiscal situation. The deficit this is expected to be a little more than 2% of GDP and next year may be even wider. The decline in oil prices and output has weighed on revenue collection. Energy accounts for nearly 40% of the government revenue.
Attempts to broaden the tax base is hampered by the fact that opposition parties control Congress and they have balked at the 2% sales tax, which had accounted for almost 40% of the improvement that President Calderon projected. It has also diluted other initiatives. The saga will continue to play out through the middle of November when self-imposed deadlines kick in.
A downgrade looms, perhaps before the end of the year, but one saving grace may be that it is well discounted in the markets, and maybe even too much. Mexico is rated BBB+ by S&P and Fitch and Baa1 by Moody's. Sovereign risk is trading at levels usually associated with high yield or junk in the CDS market. Mexico's dollar bonds have experienced their biggest decline this month since January.
Behind Mexico's economic challenges lies a political challenge. The evolution to a multiparty system is incomplete. PAN has controlled the presidency, but has not fully wrested control of the legislature. This stymies reform efforts.