USD/MXN OUTLOOK:

• Receding political risks in Mexico create a favorable backdrop for the Mexican Peso
• Market’s attention will turn to the Fed meeting next week. No changes in monetary policy are expected, but a dovish message, as many investors expect, may boost EM FX.
• Near term, USD/MXN remains in a vulnerable position and may head lower.

MEXICAN PESO FORECAST: SLIGHTLY BULLISH

The Mexican Peso finished the week relatively unchanged against the US dollar near the 19.95 mark, in a context of subdued volatility in the FX markets ahead of the Fed two day meeting next week, an event that can act as a positive variable for emerging market FX.

Turning briefly to the political backdrop before delving into the weekly outlook, the results of last Sunday's mid-term elections in Mexico, in which the ruling party coalition headed by MORENA lost its supermajority in the Chamber of Deputies, were positively received by investors, adding an additional bullish catalyst for MXN. The electoral set-back for President Andres Manuel Lopez Obrador (AMLO) will make it extraordinarily difficult for his government to enact leftist constitutional reforms that have spooked investors for the past two years. This, in turn, could boost confidence and limit future investment outflows, providing support for the domestic currency (MXN).

Elsewhere, AMLO's decision to deny a second term to Banxico’s Governor Alejandro Diaz de Leon and to tap Finance Minister Arturo Herrera to head the entity has not yet had a major impact on the Mexican peso. Although monetary policy with Herrera at the helm of the central bank may lean dovish, this will be a long-term concern, hence the muted reaction so far.

With political risks receding internally, Banxico’s leadership reshuffle in the back burner and a light economic calendar docket in Mexico, the market’s attention will turn to the FOMC two-day meeting next week. No changes to interest rates or adjustments to the forward guidance message are expected, but investors will be closely watching the new macroeconomic outlook and looking for clues on potential next policy actions.

Despite the surge in the CPI index recorded in May in the United States, the Fed is likely to reiterate that inflationary pressures are transitory and that the economy has not made substantial progress towards its employment mandate. Inflation jumped last month to its highest level since 2008, reaching 5% on an annual basis, but most of the action was in the COVID-19 sensitive components and items that can be dismissed as temporary (auto rental, airline fares, lodging, used cars, etc.). This may nudge the FOMC to stick to the script for now and call for patience.

All in all, if the US central bank maintains a dovish stance, long-term treasury yields will remain biased to the downside or rise very slowly despite the strong economic recovery. This scenario may push the dollar lower and support EM FX across the board in the short run. For this reason, the Mexican peso may gain ground against the greenback over the next couple of weeks, a situation that could drive the USD/MXN exchange rate to lows not seen since early 2020.

USD/MXN DAILY CHART