Mexican Peso Will Be More Attractive Than More Liquid Even Currencies

The cost of wagering against the Mexican peso is finally going down, which boosts its charm as a hedging tool currency in emerging markets, even when the trading volume is smaller than that of its Asian peers.

Operators can thank the decision made by the central bank last month to embark on its first cycle of flexibility in five years. If exchange market prices are to be believed, Banxico will reduce rates by 200 additional basis points by mid-2021, which would leave the benchmark below 6%. The cost of selling the peso short, now well above the average after rates doubled since 2016, will be reduced in tandem, even if it takes time to materialize.

As an attractive hedge against risk, the peso does not have much competition, which reflects the open and trade-dependent economy of Mexico and the 24-hour trading day of the peso. This is the case although the trading volume of the South Korean won and the dollars of Hong Kong and Singapore has eclipsed Mexico in the last six years. Approximately US $ 114,000 million pesos change hands every day, half the volume of the Chinese yuan, the most liquid currency in emerging markets.


"The use of the peso as indirect coverage has changed since when rates were at 3%," said Christian Lawrence, a strategist at Rabobank in New York and the leading forecaster of the Mexican peso in the last quarter. Lower rates will help restore your position, although "we would need to see enough cuts."

No other emerging market currency is in a position to exceed the peso as a preferred option to cover the risks of emerging markets.

The Hong Kong dollar, for example, is officially tied to the dollar at 7.80 per dollar and is only allowed to move 5 cents above or below. Speculators who tried to weaken the currency beyond 7.85 last year and this year have faced repeated interventions by the Hong Kong Monetary Authority, a successful defender of the fixed exchange rate for more than three decades.

The Chinese yuan presents a unique set of risks when used as coverage of emerging markets. The holders of the commercial war and geopolitical tensions over the rivalry between the United States and China tend to disproportionately weigh on the currency. In addition, Chinese policy makers, who openly warned yuan pessimists that "they would inevitably suffer a great loss," rarely hesitated to squeeze speculators with various tools.

The People's Bank of China adjusted the reserve requirements on future yuan transactions to defend against short sellers, introduced a countercyclical adjustment factor to strengthen daily monetary fixations and issued notes denominated in yuan in Hong Kong to increase the costs of financing. Many long-term yuan pessimists have ended up coming out of short-term bets of several years on the Chinese currency.

The case of the Korean won or the Singapore dollar is even weaker. While South Korea, an export power similar to Mexico, is very sensitive to conditions around the world and its currency could act as a good hedge of risk, it is only traded in won 6.5 hours a day in the market local spot compared to 24 hours for all other currencies. The Singapore dollar is marginally more liquid than the peso, although low volatility and an interventional central bank make the currency less than ideal for covering large world swings.