The Mexican peso trade has been a clear favorite of currency traders in recent months, owing to the country's strong growth fundamentals, the Mexican economy's apparent decoupling from the global economy, and the perception that the peso has been undervalued relative to other currencies and thus represents a good buy.
Recently, Societe Generale currency strategist Sebastian Galy wrote after returning from an investor trip, " If there as a ‘favourite currency’ amongst the investors I spoke with in North America, it was the Mexican peso."
However, that interest may be waning.
The chart below shows the non-commercial long positions in the peso netted against short positions, per data from the CFTC's weekly Commitment of Traders report.
As the chart shows, peso traders are clearly starting to take bullish bets off the table (although the long position is still very big):
After strengthening 12 percent against the dollar since the end of May, the peso has weakened more than 2 percent, the biggest decline among 16 most traded currencies, according to data compiled by Bloomberg. X-Trade Brokers Dom Maklerski SA, the second most-accurate forecaster, says it will depreciate another 3.9 percent by September and Bank of Nova Scotia, the third-best, recommends selling the peso. Futures traders are cutting bullish bets at the fastest rate since June.
The Bloomberg reporters attribute the recent decline in the peso to policy uncertainty on the other side of the Mexico-U.S. border:
The peso is vulnerable because Mexico, which depends on the U.S. for 80 percent of its exports, will expand 3.6 percent next year, the least since the 2009 recession, as President-Elect Enrique Pena Nieto takes office, the median of 23 economist estimates compiled by Bloomberg shows. The past month’s losses surprised investors who bought Mexican assets to take advantage of the nation’s higher interest rates at a time when the Federal Reserve was debasing the dollar.
However, Citi economists think the fundamentals in Mexico still support peso appreciation going forward:
Balance of Payments’ results for 2Q are truly remarkable. For a second consecutive quarter, the current account (CA) posted a surplus. Meanwhile, in spite of capital inflows worth USD22.4billion, the capital account registered a small USD1.8 billion deficit. From a policy perspective, determining whether these results are temporary or the result of structural change is crucial. A structurally lower CA would be compatible with a stronger real exchange rate, a lower interest rate, or a combination of both. In the case of the capital account, the effects of strong capital inflows are eased when nationals increase their holdings of foreign assets, however, policymakers face a dilemma when this becomes a long-term situation, as determining the optimal rate of absorption is extremely difficult.
Our assessment of the changing external sector suggests that, independently of its pace, the underlying trend of peso appreciation vs. the USD should continue. We conclude that conditions in the CA are clearly supportive of this trend for now and, in the future, deficits will probably be smaller than in the past. On the capital account side, we found some counterbalancing forces that should make the current capital- exporter position only a temporary phenomenon. In sum, for the mid-term we see directionality clearly biased in favor of peso strength. Albeit not our base-case scenario, we consider the case of sudden peso appreciation vs. the USD. The policy alternatives in this case would be: a. lower policy rate; b. discussions about reserve-accumulation policy, and, c. the possibility of ‘recycling’ via a Sovereign Wealth Fund.
Furthermore, comments by Banco de Mexico board member Manuel Sanchez today suggest the central bank may seek to take a more hawkish policy stance, which could help strengthen the peso further.
Perhaps the drop in long positions is only a temporary respite.
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