Reverse testing of emerging market “superweight” evidence

Bloomberg – The jitters in the US and European banking systems are testing even the most optimistic of emerging markets.

Mexican pesoswhich shocked Wall Street last year with a staggering rise, He suffered a severe setback this month. The 24-hour liquidity has left him vulnerable to quick settlement of bets on “Super weightWhen the appetite for risk among investors waned, it has currently lost about 2.7% of its value against the US dollar since March 3, when it reached its highest level in five years.

Before the outbreak of banking turmoil, the world’s hardest-hit currency at the start of the pandemic was supported by a hawkish central bank, investments in the manufacturing sector amid a rebalancing of the global supply chain and a surprisingly hawkish Attorney General’s policy.

Now, despite these positives, the peso bulls see the outlook as dependent on what happens north of the border.

Marco Oviedo, chief fixed income analyst at XP Inc. , Brazil’s largest brokerage: “Once the dust settles, the peso should go up.” “The only real risk to the peso is some kind of Fed policy error or another shock to the global economy.”

In the past year, although it has fallen in recent weeks, the peso has gained 9% against the US dollar, putting it second only to the Russian ruble in Bloomberg’s basket of 23 major emerging market currencies. The currency rose on Monday, while one-month implied volatility rose for the second day in a row.

Taking into account the strength of the dollar itself, lEven more impressive is the peso run: a measure of the real effective exchange rate for the Mexican currencywhich compares that to a broadly trade-weighted basket of currencies and is adjusted for differences in inflation levels, it rose in early March to its highest level since 2014.

Net pants

But leveraged funds have quickly unloaded long currency positions in recent weeks, going net short for the first time in a year, according to the latest positioning data compiled by the Commodity Futures Trading Commission (CFTC, acronym in English).

Of course, it’s not just about weight. Turmoil in global financial markets has also affected assets in developing countries, as traders dump riskier positions..

Tension over global growth and interest rates has fueled currency volatility, with the Mexican peso and Hungarian forint bearing the brunt.

One of the sources of support for the peso was the Bank of Mexico, which started raising interest rates in 2021. — nine months before the Fed — and raised it much higher, from 4% to 11%.

He is expected to make another quarter-point hike at the policy meeting on Thursday, which would keep Mexico’s benchmark interest rate differential on the Fed at a record 625 basis points after the US central bank’s hike last week.

But looming risks to the US economy, in the form of banking problems, are suddenly looming, highlighting the critical importance of the American consumer to the prospects of many emerging markets.

These risks threaten to undermine another major force driving the peso: the rebalancing of global trade and manufacturing patterns amid the war in Ukraine and escalating tensions between the United States and China.

An increasing number of companies are moving their production to Mexico to be closer to the US market, after widespread global supply chain disruptions in recent years. Tesla Inc. announced Recently, it will invest in a new plant that Mexican authorities estimate will cost billions.

This trend may help support a structural shift in the peso’s relationship to the Chinese currency, reversing the 20-year decline against the yuan. But in the short term The Mexican currency also depends in part on the strength of its exports, which would suffer in the event of a recession in the United States..

“So far, Mexico and the peso have benefited from the strength of the US economy, but that could change in the future,” said Carlos Capistran, head of economics for Canada and Mexico at Bank of America.

tax hawk

One source of stability that will remain is President Andrés Manuel López Obrador. When he took office in 2018, investors originally saw AMLO and its left-wing platform as too risky. Instead, it turned out to be a financial “hawk”, opting for a much stricter budget approach than many other countries, even during the worst period of the pandemic in 2020.

Now, with less than two years left in his presidency and many planned reforms already approved, investors are not expecting more policy initiatives. This sets the stage for a continuation of the status quo until a new president takes office at the end of 2024 and helps cement the peso’s bullish case.

“I wouldn’t say Mexico is risk-free, but compared to its peers, there are few immediate imbalances,” said Gabriela Soni, UBS Mexico’s chief investment strategy officer. “Investors are only starting to worry about the election that will happen in the year, so it won’t start to be talked about until 2024.”

within, The peso is likely to continue to benefit when global investors are in a risk-on mood, and to suffer when they are not.. For now, that may be largely out of Mexico’s reach, until US and European regulators can allay concerns about the state of banks in their jurisdictions.

“The Mexican foreign exchange market is competitive and almost perfect in terms of flows going in and out freely, without central bank involvement. These things make it look favourable,” said Gabriel Lozano, JPMorgan’s chief economist for Mexico and Central America.

“Overall, I’m somewhat optimistic about the recovery,” he said. “Tough times remain, especially as we approach the end of the monetary policy cycle.”

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