Best-Performing Currency Sinks as Mexico's Obrador Advances

(Bloomberg) -- Mexico’s peso, the best-performing currency this year, sank on Thursday after leftist candidate Andres Manuel Lopez Obrador gained ground in a poll and as volatility markets indicate a deeper rout closer to the elections.

The peso fell as much as 2.1 percent on Thursday after a Consulta Mitofsky survey showed Obrador’s leading with 32 percent. Investors are expecting a further dip closer to the July 1 presidential election, even though Obrador has taken some steps this year to reassure investors, such as supporting Nafta, TPP and fiscal discipline.

The peso’s six-month implied volatility surged on January 2 above 16% from around 14% in late December. An almost identical situation occurred on April 2, when three-month implied volatility surged from about 12% to above 15%.

"AMLO has been in the lead for a long time now," said Alvise Marino, a currency strategist at Credit Suisse in New York. "Markets do not freak out until you can see the event."

Best-Performing Currency Sinks as Mexico's Obrador Advances

Most peso forecasts have the currency weakening toward 19 pesos per dollar by the end of the second quarter -- just in time for the July 1 election.

For Marino, the fact that 3-month risk reversal options are pricing in favor of USD/MXN calls over puts, is a sign that investors expect significant peso depreciation around the election.

It’s common to see currency volatility surge ahead of elections, especially when investors clearly favor one pro-market candidate. Such surges, however, rarely happen so many months before election day, in Mexico or elsewhere.

During the 2016 U.S. presidential election cycle when the peso surged or fell on Donald Trump’s poll numbers, peso volatility only soared significantly in September and October, two months before the vote. Volatility markets in South Africa only started reacting about a month before the December 2017 election of the ANC president.

In Mexico, volatility is jumping for a very specific reason.

It all has to do with Lopez Obrador, said Claudia Ceja, a Mexico City-based analyst at BBVA. The candidate leads in Bloomberg’s poll tracker with 47 percent -- 21 percentage points above second place challenger Ricardo Anaya. During the campaign, he’s floated populist-leaning proposals including the rollback of foreign participation in Mexico’s energy sector and increased social spending. Last week he proposed a three-year freeze on fuel prices, even though he has also shown some signs of moderation.

Spikes were less pronounced during recent elections, Ceja said in an interview. "But in 2012, the leader was Enrique Pena Nieto," who was considered market-friendly.

Even if the peso drops as much as expected, Mexico’s economic outlook is strong enough that there may be a currency rebound, Wells Fargo strategist Erik Nelson said.

"We think there will be minimal changes to the overall policy framework in Mexico following the elections, and that Mexico’s fundamentals will remain fairly solid," Nelson said in an interview. "With real interest rates in Mexico likely to remain attractive and given our expectation for USD weakness over time, we expect MXN to stage a moderate recovery."

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