Mexico City — The Mexican peso has been appreciating consistently since mid-2020, making it one of the strongest currencies among emerging markets over the last three years. Most of the peso’s stellar performance can be attributed to external factors, including the country’s nearshoring boom and soaring remittances. However, on the domestic front, analysts have also pointed to a healthy fiscal position.
While the American currency has continued to weaken in 2023 and currently trades below the MXN$17 threshold, the lowest three years, many analysts have been anticipating a rebound for the greenback during the second half of 2023.
In fact, a Citibanamex analyst survey this month pointed to an exchange rate of MXN$17.95 per greenback by the end of the year. That would imply a 5.5% depreciation from its price of MXN$17 at the start of August. According to Blackrock, the reversal of a three-year long trend of appreciation for the peso is set to begin as soon as Banco de México (Banxico) starts cutting rates.
It’s worth noting that Banxico has remained tight-lipped as to when that might be.
To be sure, the Mexican peso has flexed its muscles so far this year, rising almost 14% against the greenback. That makes it the second-best performing currency in Latin America after the Colombian peso, which has risen more than 15%. What’s driving the US dollar’s weakness in Mexico?
Why is the Mexican Peso Appreciating?
Several analysts have shed light on peso’s upward trajectory. Among the main arguments, especially in recent months, is the rate spread between Banxico and the US Federal Reserve’s key rates, which currently stands at 575 basis points, cementing investors’ appetite for peso-denominated assets.
It’s also worth noting that, due to the Mexican economy’s strong ties to the United States, the value of the peso is particularly tethered to macroeconomic indicators north of the border, including benchmark interest rates.
Although dollar inflows via exports are still playing a role in strengthening the Mexican peso, the state-owned company Pemex has been implementing a strategy to cease crude oil exports by 2024.
While crude oil prices surged to $100 per barrel following Russia’s invasion of Ukraine, they have since tumbled to approximately $80. However, it’s crucial to note that while Mexico is a leading oil producer in Latin America, these fluctuations do not have a major impact on the exchange rate in the country.
The Mexican Peso’s Tango with the US Dollar
The performance of the Mexican peso is intricately tied to the US dollar. When the US dollar weakens, the peso strengthens, implying an inverse relationship.
One significant factor to be considered in that relationship is the US Federal Reserve’s interest rates path, as it deals with inflationary pressures. As mentioned, the value of the Mexican peso is hinged on the interest rate spread between the Bank of Mexico and the Federal Reserve, which currently stands at 600 basis points. While Mexico’s benchmark sits at 11.25%, the US’ key rates are between 5.00% and 5.25%.
This interest rate gap heightens the appeal of investing in peso-denominated assets, particularly bonds.
Priscila Robledo, an economist at Fintual, emphasized, “It makes it somewhat easier for Banxico [Bank of Mexico] to reduce inflation and might encourage them to carry out greater rate cuts at the end of the year,” speaking to Bloomberg Línea earlier this year.
Dollar Weakness Due to Remittances
The Mexican peso’s performance is also intricately linked to the influx of dollars through remittances, which workers send to their families mainly from the United States. According to BBVA Research, remittances rose for 38 consecutive months through to June this year, closing the first half of 2023 at $30.2 billion, or 9.9% more than the same six months of 2022.
These remittances are a direct result of economic growth in the US, as well as stimulus spending from the American government during the pandemic.
Keeping an Eye on Regional Political Scenarios
Investors also closely monitor the political landscape throughout the region, as exemplified by cases of heightened uncertainty in both Brazil, Colombia and Peru during 2023, mainly in relation to social protests and discord among political leaders.
Nearshoring Boom
The pandemic also ushered in changes in various processes that make up the Mexican economy. Several multinational companies have decided to relocate their manufacturing plants from China to Mexico, particularly in the northern region of the country. Known as nearshoring, this trend has garnered considerable attention from investors. Mexico’s proximity to the US implies a high potential for savings in terms of transportation and labor costs.
Analysts at Monex previously disclosed to Bloomberg Línea that nearshoring would reshape the Mexican economy through increased investment. Janneth Quiroz, Deputy Director of Analysis at Monex, remarked, “We have reports indicating a high demand for land and permits at the border. Perhaps in a scenario where interest rates are high, relocation may be more costly, but in the end, it will happen.”
— With assistance from Daniel Salazar Castellanos