Why The Mexican Peso Will Likely Rebound Before The End Of This Year

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Includes: MXNS, UUP
by: Discount Fountain
Summary

The Mexican peso has come under pressure against the U.S. dollar since the beginning of the year.

However, I anticipate that central bank intervention in Mexico will help support a stronger peso going forward.

Given improving economic growth in the United States, this could potentially fuel peso demand along with an appetite for emerging market exposure.

The Mexican peso has been under significant pressure since the beginning of 2015, trading from a level of just under 14.9 to the dollar to a current rate of 15.35 to the dollar. In spite of the pair trading at a rate of 15.75 at the beginning of June, the peso has since appreciated significantly against the U.S. dollar; at a time when major currencies such as the euro are falling in anticipation of U.S. interest rate rises. In this regard, could this mark the beginning of a potential peso rebound?

According to HSBC, the peso has come under pressure as higher interest rates in the United States could mean significant capital outflows. However, the bank also sees the peso as having the ability to make significant gains towards the end of this year, given a prospective rise in oil prices and an improving U.S. economy.

Ultimately, should the peso undergo a significant recovery, I see this as being more likely once rates in the United States have already risen. While a rise in rates would invariably increase demand for dollar-denominated assets, there is also a distinct possibility that the resulting strong economic growth in the United States may even fuel a risk-on approach and increase demand for emerging market currencies that are thought to be undervalued.

The Mexican peso stands to be an attractive proposition in this regard, as its economic fundamentals are still quite strong when compared to other economies such as Brazil and Russia. For instance, Mexican economic growth expanded by 0.4 percent in the first quarter of 2015 while Brazil and Russia both showed zero or negative growth during this period. In this context, given a time of broad slowdown for emerging markets, I see Mexico as being an attractive proposition for those investors looking to gain exposure to the same.

Furthermore, at a time when many central banks around the world are keeping domestic currencies weak through lowering interest rates, the Mexican central bank is actively taking steps to strengthen the peso; most recently extending a $3 billion plan to support the peso by selling $52 million daily in the currency market through to the end of September, along with a sale of $200 million should the peso depreciate against the dollar by more than 1.5 percent. Given that high inflation is a risk in Mexico, the central bank favors a strong currency to maintain price stability.

In conclusion, while I foresee a limited change in the peso up till the time when the Federal Reserve raises interest rates, the peso is likely to gain significantly from that point as increased U.S. economic growth helps to bolster demand for the peso and the effects of Mexican central bank intervention begin to take effect.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.