Mexican Peso Resumes Rally After Worst Week Since Trump Win

(Bloomberg) -- The sudden end to the Mexican peso’s rally in late February has proven all the more reason for traders to buy it.

While the currency sank 3.8% last week, capping its worst stretch since U.S. President Donald Trump’s election in November 2016, peso bulls have several signs pointing in their favor: it’s much cheaper, carry is attractive and a series of technical indicators suggest investors aren’t in full panic mode.

Those factors have been on display early this week. On Monday, the peso climbed by the most in six months, joining a rally in risk assets that have slumped amid concern over the spreading coronavirus epidemic. On Tuesday morning, the currency got another boost after the Federal Reserve delivered an emergency half-percentage point interest rate cut.

It’s a swift turnaround from an ugly past week. Last Monday, the currency breach its 100-day moving average and two days later it did the same for the 200-day gauge. Investors trimmed long positions for a fourth straight week, a reversal after bullish wagers soared to an all-time high in January, CFTC data show. And it’s too soon to say how much worse the virus could get: Mexico reported its first cases on Friday and the count jumped to five as of Monday. Trump said on the weekend that the U.S. is considering more controls at its southern border, and Citigroup warned clients not to buy the peso on dips.

But a variety of barometers indicate the fallout this time may be less painful than those in the past. The peso’s one-month implied forward rate of 6.9% is the fifth-highest out of 23 developing-nation peers tracked by Bloomberg. Plus, its one-month risk reversal, a measure of depreciation pressure, had spiked to the highest since November 2018. Back then, the peso advanced 3.7% the next month, trouncing all of its emerging-market peers.

The nation’s TIIE swap rates are pricing in more than 125 basis points of rate cuts for the rest of 2020, a sign investors don’t expect a drastic devaluation that would force Banxico’s hand. And while the peso’s one-month implied volatility jumped, it remains below the peaks seen in 2016, 2017 and 2018.

The options market paints a more optimistic picture. While traders have bid up peso implied volatilities across all tenors, they’re less bearish on longer-dated ones. On Monday, the spread between one-year and one-month contracts hit the lowest since June 2018.

In another positive sign, the slump sent the peso down to a support level that held during the sell-offs after Trump’s 2016 election win, the start of his trade war with China in 2018 and a brief tariff threat on Mexican goods in 2019.

The symmetrical triangle pattern, which reflects the balance between bulls and bears, signals the next big currency move could be a rally against the dollar.

Investors should expect a rebound after “typically short-lived overshooting,” BBVA analysts wrote in a client note last week. Meantime, JPMorgan strategists led by Saad Siddiqui kept their overweight recommendation Friday, saying the peso is better positioned to gain than many regional peers.

NOTE: George Lei is an FX strategist who writes for Bloomberg. The observations he makes are his own and not intended as investment advice.

--With assistance from Justin Villamil.

To contact the reporters on this story: George Lei in New York at glei3@bloomberg.net;Srinivasan Sivabalan in London at ssivabalan@bloomberg.net

To contact the editors responsible for this story: Carolina Wilson at cwilson166@bloomberg.net, Ben Bartenstein

©2020 Bloomberg L.P.