Mexican Peso Retains Positive Outlook, But Near-Term Weakness Cannot Be Ruled Out

U.S. inflation undershot expectations in August, suggesting that upward price pressures are finally starting to ease after supercharged readings in the early summer. According to the Bureau of Labor Statistics, headline CPI rose 0.3% m/m, the slowest increase since January, bringing the annual print to 5.3% from 5.4% in July. Meanwhile, core CPI, which excludes food and energy items, climbed 0.1% m/m and 4.0% y/y, two-tenths of a percent below forecasts in both cases.

It is too early to declare victory, but cooling inflation, especially in the core component, plays nicely into the transitory argument and indicates that the worst may be over, a scenario that would give policymakers more cover to be patient before removing accommodation. In layman’s terms this means that the Fed may be inclined to wait a bit longer, perhaps until December, to officially announce a plan to taper asset purchases, even more so now that the labor market has softened on delta-variant worries. For traders, more patience likely portends lower Treasury yields for longer, a negative outcome for the U.S. dollar over the medium term.

In turn, a low rate backdrop in the United States may benefit EMFX, particularly those currencies with an attractive carry such as the Mexican peso. However, for MXN to strengthen in this environment, risk appetite needs to remain supportive.

For now, it is hard to say whether sentiment will stay on the positive side, especially as strategists continue to warn of a potential correction on Wall Street on seasonality, elevated valuations, stretched positioning, and the threat of higher corporate taxes. A pullback in equity markets may activate a flight-to-safety move and wallop EMFX across the board, triggering a temporary spike in the USD/MXN exchange rate. For this reason, staying away from riskier currencies over the next two weeks, or at least until the direction of the US economy becomes clearer, may be a good approach for traders who don't like unexpected bouts of volatility.

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