Mexico’s Peso: The Six-Month Yawn

Mexico’s peso has been topsy-turvy since October 2008. The classic explanation is that developing countries with open capital markets, like Mexico, get hurt by a flight to safety in times of global uncertainty. Sure enough, after the collapse of Lehman Bros. and the onset of the global financial crisis, the peso plummeted. It was a harbinger of Mexico’s deep recession in 2009.

Early this year the peso recovered its ’08 value, feeding fears of a “super peso” that could hurt exports and the buying power of remittances. Then, from July to November 2011, the peso lost almost a fifth of its value against the greenback, leaving Mexico with the weakest performing currency in Latin America in the last half of 2011. In real terms, the peso is now about 12 percent weaker than it was in the summer of 2008.

At least three threads twine into the peso’s weakness. First, signs of slower growth in the US and EU is feeding assumptions of lower demand for goods from manufacturing countries. Hence, Mexico has been hit by flight to the dollar, as has the likes of South Korea and Poland. The exception helps prove the rule: after EU leaders announced an agreement to strengthen the currency union on Friday, the peso rallied by more than one percent.

Second, the peso is disproportionately battened by global or regional instability. Mexico’s currency is the only one in the region traded around the clock, and as such it is often treated as a proxy for Latin America. So, from a trader’s perspective, one of the easiest ways to express doubt about Latin America is to sell the Mexican peso. It’s not much of a surprise that many of the biggest hits on the peso in 2011 came overnight.

Third, to borrow a word from Agustín Carstens, Mexico’s central bank has taken a “neutral” approach to signs of a souring global economy. Brazil, Colombia and Peru all cut benchmark interest rates this year, and they have sold dollars to bolster their currencies. Mexico hasn’t cut interest rates, and only on 29 November did Banco de México announce it would sell dollars, and only in limited amounts, to prop up the peso. Without central bank intervention, the peso has been fully exposed to global volatility of late.

Combined, these factors help explain the vulnerability of the Mexican peso. But factors 1 and 2 also suggest that Mexico’s economy is softening. However, Mexico’s economic growth is accelerating, well outpacing GDP forecasts made over the past six months. There is no causation in the present currency-growth cycle. Rather, it may point to sloppiness on the part of investment banks in assessing Mexico’s economic prospects. The factors that weaken Mexico’s peso are false indicators of economic woe.